I’m getting confused about what to discount with foward and spot rates. For example if the rates are as followed

1 year 2%

2 year 3 %

Is year 2 discounted by 1.03^2 or (1.02)*(1.03).

Is there something I should be looking for in the question that clearly is saying to use one way over the other? I can never tell which way is correct

Thanks in advance

It’s always 1.03^2

The two year spot rate is the appropriate discount rate two years, but they squareroot the rate to annualize it. So to actually use it, you need to square it to unanualize it again. Same goes for other lengths that are different for a year.

They both look like spot rates; to quote a forward rate, you need to state when it starts and how long a period it covers (e.g, the 1-year forward rate starting 1 year from today).

Use 1.03².