Spot rates and forward

CFA Level I
#1

Can someone explain this: Time Annual spot rate(%) 1 15 2 12.5 3 10 4 7.5 Q- one year forward rate two year from now. I am confused with the time scale as well. Thanks S

#2

I suck at forwards and spots so two years from now you need to calculate the one year forward rate. 1.10^3 / 1.125 ^2 = 1.051 - 1= 5.1% ??? Is this right?

#3

that’s right Mr Bond ! I really get lost with these. S

#4

s here’s my best to explain forward rates. I gave up on them a long time ago, then one day dedicated 12 hours to it, and it finally clicked. the one year forward rate, one year from now. Here’s how I would solve this q 1. one year forward rate, two years from now = 1 F 2 2. the text book then says to do these steps: 3. Figure out what T and M are. In this example T = 1 (one year forward rate) and M =2 (two years from now) 4. This is important: M = DENOMINATOR. FIRST FIGURE OUT THE DENOMINATOR. They want two years from now. Two years from now, the denominator is (.125 + 1 =1.125) BECAUSE THEY WANT TWO YEARS FROM NOW, IT WILL BE 1.125, TO THE SECOND POWER. 5. Now we figure out the numerator. T= 1, so we add ONE period to M, which would give us a rate of 10, and AND WE TAKE (1.10) THE THE THIRD POWER, WHICH IS 1 F 2 (COMES TO A TOTAL OF THREE). in summary First do denominator: 1.125(2) Now do the numerator: 1.1 (3) Now do the math: 5.16%

#5

Thanks yancey, Much helpful.

#6

So if the question where a 2 year forward rate 2 years from now… Would you have to bootstrap… Can someone do this for me?

#7

2 year forward rate, two years from now = 2 F 2 T = 2 (numerator) M = 2 (denominator) First do the denominator: Two years from now = 1.125(2) Now do the numerator: Two years from M = two periods beyond M = two years beyond 12.5. The spot rate two periods beyond 12.5 is 7.5. So, 1.075(4). Now do the math: denominator = 1.125(2) numerator = 1.075(4) actually is gets a little trickier now because if T = 2, you must take the square root of the answer, and if T = 3 you have take the answer to the power of .3333, and so on. I get an answer of 2.72 for 2 F 2, can someone else confirm that please

#8

Schweser folks says we are not supposed to bootstrap but to understand he process. S

#9

you are not using bootstrap here, it is just a simple formula. i got 5.15% or so. i am too lazy to post the formula, but it is in the book. forwards are faster to calculate than bootstrapped spots