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CMA Final · Strategic Financial Management · Interest Rate Derivatives

Six-month spot rate is 6% p.a. and twelve-month spot rate is 7% p.a., both simple annualised rates. The implied 6x12 forward rate (annualised, simple interest, for the period from month 6 to month 12) is closest to:

The implied 6x12 forward rate is about 7.77% per annum. Growth over twelve months of 1.07 divided by growth over six months of 1.03 gives 1.03883, so the second half-year return is 3.883%, which annualises to 7.77%.

  1. A7.00%
  2. B8.00%
  3. C7.77%Correct
  4. D6.50%

Explanation

Compounding 1.07 (12 months) must equal 1.03 x (1 + f/2). So 1 + f/2 = 1.07/1.03 = 1.03883, giving f/2 = 3.883% and f = 7.77% p.a. Option 8.00% wrongly takes 2x7 - 6 without compounding adjustment.

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