CFA Practice Question

There are 147 practice questions for this study session.

CFA Practice Question

In the binomial interest rate tree, if i1, H is 6%, and the assumed volatility of the one year rate is 15%, i1, H is above the implied forward rate by:
A. 0.78%
B. 0.90%
C. 0.45%
Explanation: i1, L = i1, H/e = 4.4444%. The distance between the two rates is 6% - 4.4445% = 1.556%. Half of the distance is 0.778%.

User Contributed Comments 2

User Comment
Lt2201 Their answer is wrong (takes the difference and halves it, rather than using exponentials to work back to the forward rate).
The right method should be:
0.06*exp(-0.15) = 5.164% = 1 year forward rate
Thus 6% is above the forward rate by 0.836%.
jyoti The answer is correct. You take the average of the two adjacent higher and lower rate. The textbook says "The middle rate will be close to the implied one-year forward rate one year from now derived from the spot curve, whereas the other two rates are two standard deviations above and below this value."
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