FRM Part I · FRM Exam Part I · Properties of Interest Rates
The 1-year and 2-year zero rates (annual compounding) are 3% and 4%. What is the 1-year forward rate starting in one year, to the nearest 0.01%?
The forward rate is 5.01%. Divide the two-year growth factor of 1.04 squared, or 1.0816, by the one-year factor of 1.03 to get 1.0501, then subtract one. The simple approximation of 5% is slightly off because it ignores compounding.
- A4.00%
- B5.01%Correct
- C5.00%
- D3.50%
Explanation
Forward = (1.04^2 / 1.03) - 1 = 1.0816/1.03 - 1 = 1.05010 - 1 = 5.01%. 5.00% is the simple approximation 2x4 - 3. 3.50% averages the rates. 4.00% is the 2-year rate.
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