Question

The current yields for zero-coupon bonds with varying maturities are outlined in the table below. What is the forward rate from the end of year 2 to the end of Year 3? What does this rate denote?

Maturity (Years)	Yield
1	2.75%
2	3.25%
3	3.65%
4	4.00%
5	4.15%

Answer 1

We want to calculate the forward rate from the end of year 2 to the end of year 3 the formula is (1+r3)^3 = (1+r2)^2 *(1+IFR (2, 3-2))^3-2 here the number 2 and 3-2 represents the number of years, ris the interest rate for the period and IFR (2,3-2) means implied forward rate after 2 years for 1 year (3-2) 3.65% r2 3.25% (1+0.0365)^3 = (1+0.0325)^2 *(1+IFR (2,3-2))^1 (1+IFR (2,3-2))^1 = 1.036543 /1.0325^2 1.0445 IFR (2,3-2) = 1.0445 - 1 0.0445 4.45% It is the forward rate from the end of year 2 to the end of year 3, means implied forward rate for 1 year after 2 years from today.