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FRM Part I · FRM Exam Part I · Properties of Interest Rates

Which statement about forward rates and the term structure, with continuously compounded rates, is correct?

When the zero curve is flat, forward rates equal the zero rate, because the forward is the marginal rate and the average equals the marginal when it does not change. In upward-sloping curves forwards lie above zero rates, and in downward-sloping curves they lie below.

  1. AIf the zero curve is upward sloping, the forward rate for a period beyond the last maturity lies below the zero rate for that maturity
  2. BIf the zero curve is flat, forward rates equal the zero rateCorrect
  3. CIf the zero curve is upward sloping, forward rates lie below the zero curve
  4. DIf the zero curve is downward sloping, forward rates lie above the zero curve

Explanation

Forward rates are marginal rates. On a flat curve the marginal rate equals the average, so forwards equal the zero rate. On an upward-sloping curve forwards lie above the zero curve, and on a downward-sloping curve they lie below it.

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