Skip to content

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

The one-year spot rate is 3.00% and the two-year spot rate is 4.00%, both annually compounded. What is the implied one-year forward rate starting one year from now, annually compounded?

The implied one-year forward rate one year ahead is about 5.01%. It equals the two-year compounded growth factor, 1.04 squared, divided by the one-year growth factor 1.03, minus one. Averaging the spot rates or using a linear shortcut gives wrong answers.

  1. A5.01%Correct
  2. B5.00%
  3. C4.00%
  4. D3.50%

Explanation

The forward rate satisfies (1.03)(1+f) = (1.04)^2. So 1+f = 1.0816/1.03 = 1.05010, giving f of about 5.01%. The 5.00% option comes from the linear shortcut 2×4% − 3%, which ignores compounding. 3.50% is the simple average of the two spots.

Did you get it right without looking?

One question tells you little. A timed set on Bond Yields and Return Calculations shows your real accuracy, how long you take and where you lose marks.

Practise Bond Yields and Return CalculationsFree diagnostic mock

More Bond Yields and Return Calculations questions