If the spot interest rate on a prime-rated one-month CD is 6 percent today and the market rate on a two-month maturity prime-rated CD is 7 percent today, the implied forward rate on a one-month CD to be delivered one month from today is

Question

Quizplus · Accepted Answer

To calculate the implied forward rate, we need to use the formula:

(1 + R2)² / (1 + R1) = (1 + FR1)

where R2 is the spot rate for the longer maturity (2 months), R1 is the spot rate for the shorter maturity (1 month), and FR1 is the implied forward rate for the shorter maturity (1 month) that will prevail one month from now.

Substituting the given values, we get:

(1 + 0.07)² / (1 + 0.06) = (1 + FR1)

Solving for FR1, we get:

FR1 = 1 + 0.08

Therefore, the implied forward rate on a one-month CD to be delivered one month from today is 8 percent (option E).

If the Spot Interest Rate on a Prime-Rated One-Month CD