FRM Part I · FRM Exam Part I · Interest Rates
The one-year spot rate is 2.0% and the three-year spot rate is 4.0%, both annually compounded. Under pure expectations, what is the implied two-year forward rate starting one year from now (rounded to two decimals)?
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- A5.00%
- B5.03%
- C6.00%
- D6.06%Correct
Explanation
(1.04)^3 = 1.124864. Dividing by 1.02 gives 1.102808 as the two-year growth factor. Its square root is 1.05015, so the forward rate is about 5.02%... check: 1.05^2=1.1025, 1.0502^2=1.10292, so the factor 1.102808 gives about 5.016%, i.e. 5.02%.
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