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Hi. In the question are given: 3 month forward rate ( 1.9066 ) and 1 year forward rate ( 1.8901). We need to use in the question 5 month forward. How to calculated the rate? In the answers it Is done 1.9066 -( 2/9 *(1.9066-1.8901) =1.9029 . I don’t understand this calculation. Please kindly advise.
It is apportioning between the two.
Since the difference between the 3 month and the 12 month rates is 1.9066 – 1.8901 = 0.0165, and this is over a period of 9 months (12 – 3). We assume it is falling by 0.0165 / 9 each month.
We know the 3 months rate, and so the 5 months rate (which is 2 months later) will be lower by 2 x 0.0165/9 = 0.0037
So the 5 months rate is 1.9066 – 0.0037 = 1.9029
Hope that makes sense now 🙂
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