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Q.2853 Investors value the current one-year interest rate at 11.316%. However, they also forecast that for the following year, the one-year interest rate will be 13.457% and 15.658% for the year that follows next. Calculate the two- and three-year spot rates, $\rho(2)$ and $\rho(3)$, respectively. | Financial Risk Manager Part 2 Quiz - LeetQuiz

Explanation:

The correct answer is D.

The two-year spot rate $\rho(2)$ is such that:

= \frac{1}{(1.11316)(1.13457)} = \frac{1}{(1 + \rho(2))^2}

\Rightarrow \frac{1}{(1 + \rho(2))^2} = \frac{1}{(1.11316)(1.13457)}

\rho(2) = \sqrt{(1.11316 \times 1.13457)} - 1 = 0.12381 \approx 12.4\%

The three-year spot rate is such that:

\rho(3) = (1.11316 * 1.13457 * 1.15658)^{\frac{1}{3}} - 1

= 0.13463 \approx 13.5\%

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Q.2853 Investors value the current one-year interest rate at 11.316%. However, they also forecast that for the following year, the one-year interest rate will be 13.457% and 15.658% for the year that follows next. Calculate the two- and three-year spot rates, $\rho(2)$ and $\rho(3)$ , respectively.

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