How to read forward yield questions

CFA Level II
#1

1Yr yield = 4%

2Yr yield = 5%

3Yr yield=6%

What is the rate for a one year loan beginning in one year?

The answer is 1.05^2/1.04 = 5%

I am not sure if I am misreading this question but if it is the one year loan beginning in one year would we not be looking at y3/y2? As this is to do with the loan BEGINNING In one year for ONE year?

Thanks

#2

Also i noticed some answers for these types of questions show a square rooting of the yield answers and some do not. How do we know which to Square root and which not to?

#3

Yes, the question means if 1 year from now you want to take out a 1 year loan, what would the interest rate be such that you would be indifferent between borrowing for two full years versus borrowing for 1 year and renewing that loan at that time.

For your second question, you would run into a root situation if the future loan ran over more than one year. For example, if you want the rate for a 2 year loan taken out 1 year from now, the answer would be (1.06^3/1.04)^(1/2).

#4

thanks mate

#5

By the way, for whatever it’s worth,

1.05² / 1.04 − 1 ≈ 6%, not 5%.

#6

thanks S, yes was a typo!

#7

It happens to the best of us, rex.