CFA Level I · CFA Level I Exam · The Term Structure of Interest Rates: Spot, Par, and Forward Curves
The 1-year spot rate is 3.0% and the 2-year spot rate is 4.0%, both annual compounding. The implied 1-year forward rate one year from now is closest to:
The implied one-year forward rate one year ahead is about 5.0%. Compound the 2-year spot rate to 1.04 squared, equal to 1.0816, and divide by the 1-year growth factor of 1.03. The result is 1.0501, giving roughly 5.0%.
- A3.5%
- B5.0%Correct
- C7.0%
Explanation
(1.04)^2 = 1.0816. Divide by 1.03 = 1.05010, so the forward rate is about 5.0%. The 3.5% option is the simple average of the spot rates, and 7.0% is the sum of 4% twice minus... a miscalculation using 2×4% − 1%.
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