Skip to content

FRM Part I · FRM Exam Part I · Pricing Conventions, Discounting, and Arbitrage

The 2-year and 3-year zero rates are 3.0% and 3.5% respectively, both annually compounded. What is the implied one-year forward rate for the third year (annually compounded)?

The implied forward rate for year three is 4.51%. It equals the 3-year growth factor 1.035 cubed divided by the 2-year growth factor 1.03 squared, minus one. This ensures that investing for three years equals investing for two years and then rolling over at the forward rate.

  1. A3.50%
  2. B3.75%
  3. C4.51%Correct
  4. D7.50%

Explanation

Forward = 1.035^3 / 1.03^2 - 1 = 1.108718 / 1.0609 - 1 = 4.51%. The 3.50% answer just repeats the 3-year rate. The 3.75% answer averages the two rates. The 7.50% answer is 3 x 3.5% - 3.0%, which is not the correct way to isolate the third year.

Did you get it right without looking?

One question tells you little. A timed set on Pricing Conventions, Discounting, and Arbitrage shows your real accuracy, how long you take and where you lose marks.

Practise Pricing Conventions, Discounting, and ArbitrageFree diagnostic mock

More Pricing Conventions, Discounting, and Arbitrage questions