Q4 Sept/Dec'16

I will explain by calculating the year 3 forward rate (the logic is the same for the others).

The current spot yield curve rate for three years is 4.70%.
So if they were to invest for 3 years fixed, then they would get 4.70% per year.
(So after 3 years they would get X x 1.047^3 (where X was the amount invested)).

If they were to invest for 2 years fixed they would get 4.25% per year.
(So after 3 years they would get X x 1.0425^2)

The forward rate for the third year would be whatever rate for the year that would mean that investing for 2 years at 4.25% and then investing an extra year at the forward rate, would give the same as investing now for 3 years.

So….if the forward rate is R, then

(X x 1.0425^2) x (1+R) = X x 1.047^3

1+ R = 1.047^3 / 1.0425^2

I hope that makes sense 🙂

You are welcome 🙂