Forward Price... LIBOR

LorrinCFA

Table 1

Period | LIBOR Forward Rates | Implied Spot Rates

0

tikfed

which is (1+0.05949/2)^4/(1+0.054996/2)^2

wilslm

1.057492^2 / 1.052498 = 1.0625 -1 = 6.25%

neil1234

you're an equal opportunity test taker jana! I hate to be wrong on this one as I almost 99% sure it is A!

eoin

Ignore my previous post. I obviously reached only half way thru the calc :

(1+A/2)^4 = (1+0.05/2)*(1+0.055/2)*(1+0.06/2)*(1+0.065/2)
(1+B/2)^2 = (1+0.05/2)*(1+0.055/2)

Where A is the spot rate over 2 years , B is the spot rate over 1 year.

So the foward rate on a 1 year term , 1 year from now

is SQRT( (1+0.05/2)*(1+0.055/2)*(1+0.06/2)*(1+0.065/2) / (1+0.05/2)*(1+0.055/2) )

= 1.03125

And the annualized rate is 6.25%

spreads

Your answer: B was incorrect. The correct answer was A) 6.25%.

The 2 year spot rate is 5.7492 meaning the return that should be earned after 2 years would be 5.7492 + 5.7492 = 11.498%. The 1 year spot rate is 5.2498 therefore the 1 year forward rate 1 year from now must be the difference between the 11.498% earned over the 2 year spot rates and the 1 year spot rate. Thus the 1 year forward rate 1 year from now is 11.498 − 5.2498 = 6.2486 or 6.25%. (Study Session 14, LOS 53.e)

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The above explanation is kind of strange to me. Atleast I have not seen anywhere in text where we subtract 1yr spot rate from 2yrs spot rate to get 1yr forward rate 1yr from now....

SFoyil

That's the approximate way.

The exact way is to divide : (1+2YrSpot)^2/(1+1YrSpot)

so Forward rate for 1 year , 1 Year from now = (1.057492^2)/1.052498

which gives you in one stroke 1.06251 , or 6.25%

MiniMe7

in this case I would not calc anything

just look at given forward rates
12

random_walker47

you are right Dreary, if there were more choices between 6 and 6.5, it would be necessary to calc either your way or:
(1+0.06/2)x(1+0.065/2)



Edited 1 time(s). Last edit at Saturday, May 22, 2010 at 02:32PM by pfcfaataf.

madaochenggong

Dreary , you got the wrong rate in there man.

Only LIBOR can be divided by 2 , 4 etc. Spot rates are compund rates , never simple return rates.

You are dividing 057492/2.

i.e. Spot Rates / 2 . Thats a no-no. Instead it can be ( 1+ LIBOR/2)

You want to compound the spot rates that's fine . But don't divide by 2 . Take Sqrt if you have to .

The answer is so close to 6.25 % that it is impossible to say its rounding error. It looks very close to exact.