CFA Level I · CFA Level I Exam · Fixed-Income Bond Valuation: Prices and Yields
Spot rates are 2.00% for one year and 3.00% for two years (annual compounding). The implied one-year forward rate one year from today is closest to:
The forward rate is the two-year compounded growth divided by the one-year growth, minus one: 1.0609 divided by 1.02 is 1.0401, so about 4.01%. Averaging the spot rates ignores compounding and understates the forward rate.
- A2.50%
- B3.00%
- C4.01%Correct
Explanation
(1.03)^2 = 1.0609. Dividing by 1.02 gives 1.04010, so the forward rate is 4.01%. The 2.50% answer is the simple average of the spots, which ignores compounding and the forward logic. The 3.00% answer is just the two-year spot.
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