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FRM Part I · FRM Exam Part I · Bond Yields and Return Calculations

The annually compounded spot rates are 3.0% for 1 year and 4.0% for 2 years. What is the implied 1-year forward rate starting in one year, closest to?

The implied one-year forward rate one year ahead is about 5.01%. It equals 1.04 squared divided by 1.03, minus one. Forward rates come from the ratio of discount factors, not from averaging spot rates or subtracting them.

  1. A3.50%
  2. B5.01%Correct
  3. C4.00%
  4. D1.00%

Explanation

(1.04)^2 = 1.0816. Dividing by 1.03 gives 1.05010, so the forward rate is 5.01%. The simple average of 3.50% ignores compounding and the distinction between spot and forward rates. The 1.00% option is the difference of the spot rates.

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