The spot rate for year 1 is 7.5% and the forward rate for year one to two is 8%. The two-year discount factor is

Question

Quizplus · Accepted Answer

To calculate the two-year discount factor, we need to first calculate the one-year forward rate for year 2:

(1 + 0.08)^2 = (1 + 0.075)(1 + 1f1,2)

1f1,2 = ((1 + 0.08)^2/(1 + 0.075)) - 1 = 0.082 (rounded to three decimal places)

Using the one-year forward rate, we can calculate the two-year discount factor:

(1 + 1f1,2)^2 = (1 + 0.075)(1 + d2)

d2 = ((1 + 1f1,2)^2/(1 + 0.075)) - 1 = 0.861

Therefore, the answer is B, with a two-year discount factor of 0.861.

The Spot Rate for Year 1 Is 7