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FRM Part I · FRM Exam Part I · Bond Yields and Return Calculations

A 1-year zero-coupon bond yields 4% and a 2-year zero-coupon bond yields 5%, both with annual compounding. What is the implied 1-year forward rate starting in one year, to two decimals?

The implied one-year forward rate one year ahead is 6.01%. Divide the two-year growth factor of 1.05 squared, 1.1025, by the one-year growth factor of 1.04, which gives 1.0601. This is the rate that makes rolling over equal holding the two-year zero.

  1. A5.00%
  2. B5.01%
  3. C6.01%Correct
  4. D6.50%

Explanation

Forward f satisfies (1.05)^2 = 1.04 × (1+f). So 1.1025/1.04 = 1.06010, giving f = 6.01%. The simple average 4.5% or the 2-year yield 5% ignore compounding; 6.00% from the 2×5%−4% shortcut is slightly off, and 6.01% is the exact value.

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