I am asked to comment on the Funds Transfer Pricing methodology used by our Treasury to assign a Cost of Funds to a Loan. This is the current methodology: Let us say there is a 2 year loan with an annual payment and each payment pays down half of the principal (+ some interest).
The FTP is calculated by Treasury as: `
SUMPRODUCT(Year,% of Principal,Bank's Borrowing Cost)/SUMPRODUCT(Year,Bank's Borrowing Cost)
Is this correct?
If it were me, I would just calculate the Macaulay Duration of the Loan and lookup the borrowing cost corresponding to that duration.