The current yield on a 2-year Treasury note is 1.21 percent and that on a 3-year note is 1.70 percent. This means that the implicit 1-year forward rate in year 3 is
A) Equal to 1.21 percent
B) Above 1.70 percent
C) Equal to 1.70 percent
D) Below 1.21 percent

Question

Quizplus · Accepted Answer

The implicit 1-year forward rate in year 3 can be calculated using the formula that equates the return of investing in the 3-year note directly to the return of investing in the 2-year note and then reinvesting the proceeds for one more year at the forward rate. Given that the forward rate is calculated to provide an equivalent return, and considering the upward slope of the yield curve from 1.21% to 1.70%, the forward rate for the third year must be above 1.70% to compensate for the lower yield in the first two years.

The Current Yield on a 2-Year Treasury Note Is 1