CFA Level I · CFA Level I Exam · The Term Structure of Interest Rates: Spot, Par, and Forward Curves
Spot rates are 2.00% for one year, 3.00% for two years and 4.00% for three years, all annual-pay. The two-year forward rate starting one year from now (the 1y2y rate) is closest to:
The 1y2y forward rate is about 5.01% per year. It equals the square root of the three-year growth factor of 1.124864 divided by the one-year factor of 1.02, minus one. The 4.51% option is a distractor from averaging errors.
- A3.00%
- B4.51%Correct
- C5.01%
Explanation
(1+f)^2 = 1.04^3 / 1.02 = 1.124864/1.02 = 1.102808. The square root is 1.05015... check: 1.0501^2 = 1.10271, so f is about 5.01%.
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