A one-year STRIPS sells at an interest rate of 6.40 percent, and a two-year STRIPS sell at an interest rate of 6.10 percent. What is the implied one-year forward rate? Assume that rates are effective annual rates.

Question

Quizplus · Accepted Answer

The implied one-year forward rate is the rate that is implied by the current yields on a one-year bond and a two-year bond. It can be calculated using the formula:

(1 + r2)^2 = (1 + r1) x (1 + f1)

where r1 is the yield on the one-year bond, r2 is the yield on the two-year bond, and f1 is the implied one-year forward rate.

Plugging in the numbers, we get:

(1 + 0.061)^2 = (1 + 0.064) x (1 + f1)

Solving for f1, we get:

f1 = 0.058 or 5.80%

Therefore, the implied one-year forward rate is 5.80%. The best choice is B.

A One-Year STRIPS Sells at an Interest Rate of 6