11.2 Transfer Pricing Methodologies and Rules

The transfer pricing methodologies supported by Oracle Funds Transfer Pricing can be grouped into the following categories:

Cash Flow Transfer Pricing Methods: Cash Flow transfer pricing methods are used to transfer price instruments that amortize over time. They generate transfer rates based on the Cash Flow characteristics of the instruments.

To generate cash flows, the system requires a detailed set of transaction-level data attributes, such as, origination date, outstanding balance, contracted rate, and maturity date, which resides only in the Instrument tables. Consequently, Cash Flow methods apply only if the data source is Account tables. Data stored in the Management Ledger Table reflects only accounting entry positions at a particular point in time and does not have the required financial details to generate cash flows, therefore, preventing you from applying Cash Flow methodologies to this data.

The Cash Flow methods are also unique in that Prepayment rules are used only with these methods. You can select the required Prepayment rule when defining a Transfer Pricing Process.

Oracle Funds Transfer Pricing supports the following Cash Flow Transfer Pricing methods:

Non-Cash Flow Transfer Pricing Methods: These methods do not require the calculation of cash flows. While some of the non-cash flow methods are available only with the Account tables data source, some are available with both the Account and Ledger table data sources.

Oracle Funds Transfer Pricing supports the following Non-Cash Flow Transfer Pricing methods:

Oracle Funds Transfer Pricing also allows Mid-period Repricing. This option allows you to take into account the impact of high market rate volatility while generating transfer prices for your products. However, the mid-period repricing option applies only to adjustable-rate instruments and is available only for certain Non-Cash Flow transfer pricing methods.

Note on Bulk Updates versus Row-by-Row Processing: Any TP method that does not refer to individual account characteristics utilizes a bulk update to assign a single transfer rate to a group of instrument records. Any TP Method that needs to refer to individual account characteristics to process will execute on a row-by-row basis. In general, Bulk updates are faster than row-by-row processing.

The following TP methods, when not defined through a conditional assumption and not utilizing Mid-Period Repricing, use Bulk Updates:

  • Redemption Curve (Assignment Date = As-of-Date only)
  • Moving Average
  • Spread from Note Rate
  • Spread from IRC (Assignment Date = As-of-Date only)

All other TP Methods like Tractor, Caterpillar, and Weighted Average Perpetual are processed row-by-row. When Conditional Assumptions or Mid Period Repricing are used, processing will always be row-by-row, regardless of the TP Method selection.

  • Cash Flow: Average Life
    The Average Life method determines the average life of the instrument by calculating the effective term required to repay half of the principal or nominal amount of the instrument. The TP rate is equivalent to the rate on the associated interest rate curve corresponding to the calculated term.
  • Cash Flow: Duration
    The Duration method uses the Macaulay Duration Formula:
  • Cash Flow: Weighted Term
    The Weighted Term method builds on the theoretical concepts of duration. You can use the Cash flow Duration TP method approach to the Cash Flow Weighted Term method. Based on that, the following Cash Flow Discounting Methods are used:
  • Cash Flow: Zero Discount Factors
    The Zero Discount Factors (ZDF) method takes into account common market practices in valuing fixed-rate amortizing instruments. For example, all Treasury strips are quoted as discount factors. A discount factor represents the amount paid today to receive $1 at maturity date with no intervening cash flows (that is, zero-coupons).
  • Moving Averages
    Under this method, a user-definable moving average of any point on the transfer pricing yield curve can be applied to a transaction record to generate transfer prices. For example, you can use a 12-month moving average of the 12-month rate to transfer price of a particular product.
  • Straight Term
    When you select the Straight Term method and Standard Term approach, the system derives the transfer rate using the last repricing date and the next repricing date for adjustable-rate instruments, and the origination date and the maturity date for fixed-rate instruments.
  • Spread from Interest Rate Code
    Under this method, the transfer rate is determined as a fixed spread from any point on an Interest Rate Code. The following options become available on the application with this method:
  • Spread from Note Rate
    To generate transfer prices using this method, you need to provide just one parameter: a rate spread. This spread is added or subtracted from the coupon rate of the underlying transaction to generate the final transfer rate for that record.
  • Redemption Curve
    This method allows you to select multiple-term points from your transfer pricing yield curve and calculate an average transfer rate based on the weights you assign to each term point. The following options become available in the application with this method:
  • Reference Period's Compounded Rate
    This Transfer Pricing method is to support IBOR transition. Preferably IRC should be Risk-free rate compounded index. As per the selected period, system picks the compounded index for the reference period start date and does the calculation till the reference period end date as follows:
  • Tractor Method
    The Tractor Method extends the concept of “Strip Funding” to instruments that do not have contractual cash flows.
  • Caterpillar
    The Caterpillar method extends the concept of “strip funding” to instruments that do not have contractual cash flows.
  • Weighted Average Perpetual
    This method calculates the simple weighted average of the applicable balance based on maturity bands defined through a Behavior Pattern. In the following example, the end of period balance as of Jan 31 is split into Core and Volatile strips, and the relevant rates are applied to arrive at the weighted average Transfer Rate.
  • Unpriced Account
    Under the unpriced account method, the transfer rate for the account is defined as the weighted average of the Product dimension members. While using the unpriced account methodology, you can specify whether the weighted average of transfer rates has to be taken across all organizational units or for accounts only within that organizational unit.
  • Risk Free Reference Rates
    Risk Free Reference rates (RFR) could be used for following two methodologies, based on what is selected in UI:
  • Transfer Pricing Methods and the Mid-Period Repricing Option
    The mid-period repricing option allows you to take into account the impact of high market rate volatility while generating transfer rates for your products. However, the mid-period repricing option applies only to adjustable-rate instruments and is available only for the following non-cash flow transfer pricing methods:
  • Defining Transfer Pricing Methodologies Using Node Level Assumptions
    In Oracle Funds Transfer Pricing, your product portfolio is represented using the Product Dimension specified in your FTP Application Preferences. Node Level Assumptions allow you to define transfer pricing, prepayment, and adjustment assumptions at any level of the Product dimension Hierarchy. The Product dimension supports a hierarchical representation of your chart of accounts, so you can take advantage of the parent-child relationships defined for the various nodes of your product hierarchies while defining transfer pricing, prepayment, and adjustment assumptions. Child nodes for which no assumptions are specified automatically inherit the methodology of their closest parent node. Conversely, explicit definitions made at a child level will take precedence over any higher-level parent node assumption.
  • Associating Conditional Assumptions with Assumption Rules
    Oracle Funds Transfer Pricing extends the setup and maintenance of assumptions by allowing users to integrate conditional logic (optional) into the setup of transfer pricing, prepayment, and TP adjustment methods. The Caterpillar method under Transfer Pricing Rules will not be available for selection under Conditional Assumptions.

Parent topic: OFS Funds Transfer Pricing Overview