Calculate 1-year forward rate in two years time. Show your workings clearly.

General formula for Forward rate over later years is fn = (1 + rn)n / (1 + rn

n-1
-1) -1
where:
fn = forward rate over the nth year
rn = n-year spot rate
rn -1 = spot rate for n - 1 year

Maturity Spot rates

(years) (%)
1 5
2 6.5
3 7.5
Forward rate over later years
Forward rate over the first year =
one-year spot rate. Thus, no need
to calculate
f2 = (1+0.065)2 / (1+0.05) - 1
= (1.065)2 / (1.05) - 1
= 1.1342 / 1.05 - 1 = 0.0802
f3 = (1+0.075)3 / (1+0.065)2 - 1
= (1.075)3 / (1.065)2 - 1
= 1.2423 / 1.1342 - 1 = 0.0953