# forward rates

The folowing interest rate information is observed: Spot rates: 1 YEAR: 10% 2 YEARS: 11% 3 YEARS: 12% Base on this data, the 2-year forward rate one year from now is closest to: Answer: 13% Could some one help me on this? thanks!!!

1.12^3 = 1.1 * (1+1f2)^2 1f2 = 1.1301 - 1 = 13.01% CP

What I still can’t understand is if it is asking about “the 2-year forward rate one year from now: 2f1” or the “1-year forward rate two years from now: 1f2” I was doing: 1f2: 1.12^3/1.11^2 - 1

2 year forward rate 1 year from now is 1f2 per the book. 1 year forward rate 2 years from now is 2f1. remember the 2nd number is the power to which you raise that rate. so per the problem --> you have a 1 year 10% spot rate. You hold it for 1 year, and then for 2 years at the 2 year forward rate 1 year from now. You end up at the 3 year spot rate. I know Stalla and the book have differing conventions with regards to this. Read the text, it is easier to follow, does seem a little difficult in the beginning. Solve the problems in the back of the book --> and then this becomes much easier to follow. CP

I’ll review it. Thank you again, very helpful !!