Question

Suppose the spot rates for 1 and 2 years are s1=6.3% and s2=6.9% with annual compounding. recall that in this course interest rates are always quoted on an annual basis unless otherwise specified. what is the forward rate, f1,2 assuming annual compounding?

Answer 1

Since the problem assumes annual compounding, then the relationship of forward rate and spot rates is given in the equation:

f1,2 = ((s2^2 / s1) - 1)

Therefore,

f1,2 = ((1.069^2 / 1.063) - 1)

f1,2 = 0.075 = 7.5%

Forward rate is 7.5%.