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Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Forward rates
Hi
How do you work out a 5 month forward rate if only 3 month and 1 year forward rate is given.
Please explain with example.
Thank you
Noreen
You approximate between the two assuming that they vary linearly. (They don’t, which is why it is only an approximation).
For example, suppose the following:
Spot rate ($/GBP) 2.0000
3 month forward 2.0100
12 month forward 2.1000
So….the difference between 3 and 12 month is 2.1000 – 2.0100 = 0.0900
This is over (12-3=) 9 months, so it is changing by 0.0900/9 – 0.0100 per month
If we want 5 months forward, this is 2 months later than 3 month forward (5-3=2)
so we assume that the 5 month rate will be different from the 3 month forward by 2 months at 0.0100 per month.
This gives a 5 month forward rate of 2.0100 + 2*0.0100 = 2.0300
Hope that helps!