FRM Part I · FRM Exam Part I · Interest Rates
The 1-year spot rate is 3% and the 2-year spot rate is 5%, both annually compounded. What is the 1-year forward rate starting one year from now, with annual compounding?
The forward rate is 7.04%. Dividing the two-year growth factor of 1.1025 by the one-year growth factor of 1.03 gives 1.07039. Simply computing 2×5% − 3% gives 7.00%, which ignores compounding.
- A7.04%Correct
- B7.00%
- C4.00%
- D8.00%
Explanation
No-arbitrage requires (1.05)^2 = (1.03)(1+f). So 1+f = 1.1025/1.03 = 1.07039, giving f = 7.04%. Using 2×5% − 3% = 7.00% is only a linear approximation. It ignores compounding and is not the exact forward rate.
Did you get it right without looking?
One question tells you little. A timed set on Interest Rates shows your real accuracy, how long you take and where you lose marks.
More Interest Rates questions
- A zero-coupon investment pays 8% per annum with semiannual compounding. What is the equivalent continuously compounded rate, to two decimals…
- A short-term interest rate futures contract matures in 4 years, and the underlying rate covers the period to 4.25 years. The futures rate is…
- A two-year bond has a face value of 1,000 and pays an annual coupon of 5%. Its yield to maturity is 4% per year, compounded annually. What i…
- A SOFR-style 3-month futures contract has a notional of USD 1,000,000 and pays USD 25 per basis point (0.01) move in the quoted rate for a 3…
- Continuously compounded zero rates are 3.0% for 1 year and 3.5% for 2 years. What is the implied continuously compounded forward rate for th…
- A bond is priced at 100 with a modified duration of 7 and a convexity of 60. If its yield falls by 100 basis points, what is the new price e…