Can someone please explain the solution for Q1 in Reading 35 (CFAI text, Vol 4) - the question requires us to calculate the swap price given the following 1) 1-year and 2-year fwd price for oil is $22 and $23 resp. 2) 1-year and 2-year interest rates are 6% and 6.5% I did, 22/(1.06) + 23/(1.06)(1.065) to calculate the PV of the two prices(and I believe that is how Schweser does it too). CFAI does 22/(1.06) + 23/(1.065)(1.065). Whyyyyyy?
These are forward rates (not spot rates) . You use them to get the Forward Discount Factors for each year 1/(1+Fi)^i
I may be missing a very basic point here, but don’t these rates mean 1 year fwd rate today (6%)and 1 year fwd rate 1 year from now (6.5%)
You’re discounting it back so: 22/(1.06^1) + 23/(1.065^2) = 20.755 + 20.278 = 41.03
If someone says 2-yr interest rate is 6.5% that means that the spot rate is 6.5%/ year so the 1yr forward rate 1yr from now is that thing you get by bootstrapping.
1F1 i think is around 7%…if I recall the math correctly.
1F1 = (1.065^2 / 1.06) - 1 = .0704 or 7.04%
Got it, Thanks guys!
6.5% is the 2 year spot rate … the forward rate is 7%… there is an implied lending in the swap one year from now and u earn an interest at 7% (on the amount u overpay at the end of one year)