CMA Final · Strategic Financial Management · Interest Rate Derivatives
A company holds the following zero-coupon spot rates (annual compounding): 1-year 6.00%, 2-year 7.00%. What is the implied 1-year forward rate one year from now (to two decimals)?
The implied one-year forward rate one year hence is about 8.01%. It equals (1.07 squared divided by 1.06) minus one, which is 1.1449 divided by 1.06 minus one. Simple averaging giving 7.5% ignores compounding and is incorrect.
- A8.01%Correct
- B7.50%
- C8.50%
- D7.00%
Explanation
(1.07)^2 = 1.1449. Divide by 1.06 = 1.08009. Forward rate = 8.01%. The simple average of 7.50% ignores compounding, so it is wrong.
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