Skip to content

CMA Final · Strategic Financial Management · Interest Rate Derivatives

A firm wants the forward rate for the period from year 1 to year 2. The 1-year spot rate is 6% p.a. and the 2-year spot rate is 7% p.a. (annual compounding). What is the implied 1-year forward rate one year from now, approximately?

The implied one-year forward rate one year ahead is about 8.01%. It equals (1.07 squared divided by 1.06) minus one, because holding for two years at 7% must equal holding one year at 6% and then rolling at the forward rate.

  1. A8.01%Correct
  2. B7.50%
  3. C6.50%
  4. D8.50%

Explanation

(1.07)^2 = 1.1449. Dividing by 1.06 gives 1.08009, so forward rate = 8.01%. The 7.50% option wrongly takes a simple average of the two rates, which ignores compounding. 6.50% and 8.50% are not derived from the data.

Did you get it right without looking?

One question tells you little. A timed set on Interest Rate Derivatives shows your real accuracy, how long you take and where you lose marks.

Practise Interest Rate DerivativesFree diagnostic mock

More Interest Rate Derivatives questions