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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%

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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....

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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%

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

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

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

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