CFAI Fixed Income (Volume 5) Page 304 question 3: I'm Stumped

I don’t understand this answer. I thought year one rates are the 1 year forward rates one year from now. Would someone please enlighten me?

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this is one i got right…

A is wrong because you calculate in the opposite direction.

B… this could be right. however e^0.4 is too small for the numbers to work. you don’t even need to know the formulae.

C. you expect the tree to be symmetric, so the numbers on the middle node should be zero volitility forward rates. i.e. from Y1-Y2 so it’s the best answer.

it’s a trick question. you see the 4 nodes, the 10% vol and want to go for B.

The answer should be A.

Node 2-2 should be the 1-year forward rate _ 2 years _ from now.

Node 3-2 is Node 2-2 * e^(0.2)

No, node 2-1 is 2-2* e^(.2) - A is not possible

I understand how A and B are wrong, but shouldn’t Node 2-2 be the 1 year forward rate 2 years from now? As opposed to the the answer which states that it is the one year forward rate one year from now.

I literally just posted the same thing! I think CFAI have made a mistake and it’s not in the errata. I expect that what you say is correct. At least A and B are easy to rule out… There are lots of mistakes in the Fixed Income readings that cause unnecessary confusion and wasting of time… not impressed…

I think answer C is fine. Node 2-2 is the 1 year forward rate from point of time Node 1, Node 1 is one year from today so Node 2-2 is 1-year forward rate starting one year from today, i.e. f(1,1).