FRM Part I · FRM Exam Part I · Interest Rates
Annually compounded spot rates are 2.0% for one year, 3.0% for two years and 4.0% for three years. What is the implied one-year forward rate two years from now (the 2y1y forward), to the nearest basis point?
The 2y1y forward rate is about 6.03%, computed as (1.04)^3 divided by (1.03)^2 minus one. The forward is the rate that makes investing for two years then one more year equal to investing for three years at the three-year spot rate.
- A5.00%
- B5.01%
- C6.03%Correct
- D6.00%
Explanation
(1.04)^3 = 1.124864 and (1.03)^2 = 1.0609. Ratio = 1.124864/1.0609 = 1.06029, so the forward is about 6.03%. The simple-average shortcut of 5.00% ignores compounding, and 6.00% is only a rounded approximation.
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