CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

An analyst gathers the following information:

Years to Maturity Spot Rate
1 5.00%
2 6.00%
3 6.50%

Based on the data above and assuming annual compounding, the one-year implied forward rate two years from now is closest to ______.
A. 6.25%
B. 7.01%
C. 7.51%
Explanation: [(1 + 6.5%)3/(1 + 6%)2]1 - 1 = 7.51%.

User Contributed Comments 10

User Comment
synner note: [(1.0325^3/1.03^2] -1) *2 = .075

{(1.0325^6/1.03^4)^.5 - 1} * 2 = .075
yizhang 1.065^3/1.06^2-1=7.51%
Becker Can somebody explain ?
steved333 (1+ 3rd-period spot^3)/(1+ 2nd period spot^2)- 1
Third period because it's 1 year after the second year and the question asks for the 1-year rate in the second year...
dlukas A CF occuring in two years would be discounted by dividing by (1.06)^2. A CF occurring in three years would be divided by (1.065)^3. So to discount a CF occurring in 3 years back one year (which is the one-year forward rate two years from now), take (1.065)^3 divided by (1.06)^2--that's your divisor for that CF. Subtract 1 and that's your forward rate. It helps me to take a hypothetical CF and map it out on a timeline to make sure I have all my exponents right.
otterom Thanks, dlukas!
zed888 why don't we assume semi annual compounding?
bidisha Is there a way to do it on baii using the cf function
miropower one can also use approximation: we could approximate as
(3x6.50)-(2x6) = 7.50 for a quick answer which is pretty close to 7.51
Logaritmus May be it easier to get from discount factors (value of 1 at time T), Discount factor function is the best method to describe structure of interest rates.

DF(2Y) = 1.06^(-2) = 0.89
DF(3Y) = 1.065^(-3) = 0.82785

Then DF (2Y) * (1+implied rate)^(-1)= DF(3Y)
and finally 1 + implied rate = DF(2Y)/DF(3Y) = 1.07507
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