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PREDICTING FORWARD RATES

AABDULLAHI4y ago
Hi, looking at kaplan, i saw the prediction of forward rates from the given spot yield rates being presented as the rate of the following year divided by the current year rate while it is raised to number of relevant years in each. for example if rates are 5%,7% and 8% in year 1,2 and 3, the forward rate for year 2: 1.07^2/1.05 and year 3: 1.08^3/1.07^2 while year 1 stays 5%. could you please help me understand which formulae this could be? thanks
John MoffatJohn MoffatTutor4y ago#1
It isn't a specific formula. It is calculating the rate for the second year and for the third year. The 7% in your example is the effective annual rate per year for a deposit of 2 years. So at the end of two years the amount would be multiplied by 1.07^2. Given that the rate in the first year is 5% and if the rate in the second year was R, then after 2 years a deposit would have been multiplied by 1.05 x (1+R). So 1.05 x (1+R) = 1.07^2, therefore 1+R = 1.07^2 / 1.05 It is the same logic when calculating the year 3 rate.
AABDULLAHI4y ago#2
Wow that's really nice. thanks again. now i see the logic.
John MoffatJohn MoffatTutor4y ago#3
You are welcome.
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