CFA Level I · CFA Level I Exam · The Term Structure of Interest Rates: Spot, Par, and Forward Curves
The spot curve is upward sloping. Relative to the two-year spot rate, the forward rate for a one-year loan starting in two years (2y1y) is most likely:
The 2y1y forward rate is most likely higher than the two-year spot rate. With an upward-sloping spot curve, the marginal rate for year three must exceed the average rate over the first two years, so the forward curve lies above the spot curve.
- Alower than the two-year spot rate
- Bequal to the two-year spot rate
- Chigher than the two-year spot rateCorrect
Explanation
When spot rates rise with maturity, the three-year spot rate exceeds the two-year rate. The forward rate covering year three must be higher than the two-year spot rate to lift the three-year average. So the forward curve lies above the spot curve.
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