Compound interest and Funds transfer pricing: Difference between pages

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Compound interest is calculated as ‘interest on interest’ as well as interest on the original principal amount.
''Banking''.


Compound interest per year is the usual quotation basis for periods of more than a year.
(FTP).


To calculate compound interest for different periods we compound up or de-compound the interest depending on the relative lengths of the periods being considered.
Funds transfer pricing deals with the internal prices for funding, within a bank.


For example, interest quoted at 6% per annum, compounded annually, for two years maturity, with all of the interest paid at the final maturity, means that the interest paid after two years will be (compounding up for two periods):
FTP methodologies are important because they affect a bank’s internal profit allocation, and thereby influence business lines’ activities and appetite for risk.


= [1.06 x 1.06] - 1
= 12.36% periodic interest for the two year period.


Decompounding is used to calculate periodic interest for a shorter period.
For example, if a bank's FTP leads to funding costs being underestimated, the bank’s lending unit may offer cheaper loans to customers - and expand lending volumes - in the mistaken belief that this lending is profitable.
For example, if periodic interest is 12.36% for a two-year period, this means the total accumulated interest payable/receivable at the end of the two years is 12.36%.


Decompounding the 12.36% (per two years) to calculate the interest for just one year:
One year's interest = (1 + 0.1236)<sup>(1/2)</sup> - 1
= 6.00% per one-year period.


== See also ==
== See also ==
* [[CAGR]]
* [[IRRBB]]
* [[Compounding effect]]
* [[Transfer price]]
* [[Periodic rate of interest]]
* [[Simple interest]]
 

Revision as of 12:19, 24 August 2016

Banking.

(FTP).

Funds transfer pricing deals with the internal prices for funding, within a bank.

FTP methodologies are important because they affect a bank’s internal profit allocation, and thereby influence business lines’ activities and appetite for risk.


For example, if a bank's FTP leads to funding costs being underestimated, the bank’s lending unit may offer cheaper loans to customers - and expand lending volumes - in the mistaken belief that this lending is profitable.


See also

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