The correct answer is 13.01%. Derived using the formula (1.10)(1+x)^2=(1.12)^3. And yes, (1+x)^2 is the 2 year forward rate one year from today. The 10% is the rate between now and the end of 1 year. If at the end of 1 year, i was going to take my loan and roll it over into a 2 year loan, I would be willing to accept a rate of 13.01% for the two year loan based on the current term structure of spot rates.
should be 2f1, sorry, the math stays the same
where is that formula in the notes? (1.10)(1+x)^2=(1.12)^3
another way to see if this makes sense is to think about your return. If i make a 3 year loan, I will get as 12% rate, however if i do a 1 year loan i will only get 10% (which is lower than 12%), so if i were going to roll it into a 2 year loan following the maturity of a 1 year loan, in order to be indifferent between the 1 year + 2 year forward loan and the straight 3 year loan, my forward 2 yr rate will need to be larger than than the 3 year spot rate in this example. Think about it. It makes perfect sense.
mib20 Wrote: ------------------------------------------------------- > another way to see if this makes sense is to think > about your return. If i make a 3 year loan, I > will get as 12% rate, however if i do a 1 year > loan i will only get 10% (which is lower than > 12%), so if i were going to roll it into a 2 year > loan following the maturity of a 1 year loan, in > order to be indifferent between the 1 year + 2 > year forward loan and the straight 3 year loan, my > forward 2 yr rate will need to be larger than than > the 3 year spot rate in this example. Think about > it. It makes perfect sense. ok that makes a bit more sense intuitively. so is the (1 + 2f1) squared because it’s a two year loan?
zizou Wrote: ------------------------------------------------------- > where is that formula in the notes? > > (1.10)(1+x)^2=(1.12)^3 it is just simple forward rate theory. You don’t need to see that specific equation to understand it. I am sure that if you understand forward rate calculations as presented in either schweser or cfai this will be intuitive.