The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years aheadis ____ percent.
A) 1.8
B) 9
C) 15
D) none of the above

Question

Quizplus · Accepted Answer

The formula for the forward rate is:

Forward rate = [(1 + interest rate on n-year security) ^ n] / [(1 + interest rate on m-year security) ^ m] - 1

Where n > m

Using the formula, we can calculate the forward rate two years ahead:

Forward rate = [(1 + 0.13) ^ 3] / [(1 + 0.09) ^ 1] - 1

Forward rate = (1.5301 / 1.09) - 1

Forward rate = 0.4018 or 40.18%

Therefore, the answer is C) 15 (rounded to the nearest whole number).

The Annualized Yield on a Three-Year Security Is 13 Percent;