A forward rate is the borrowing / lending rate in the future. The logic is that the return from investing in a 2-year bond is the same as that from investing in a 1-year bond and then rolling the proceeds into a second 1-year bond one year from now.
Forward rate from period 1 to period 2 = (1 +Z2)2 / (1 + Z1) – 1
Where:
Z1 is the spot rate for 1-year
Z2 is the spot rate for 2-year.
Given the forward rates, calculate spot rate
(1+Z3)3 = (1+ f1)(1+f2)(1+f3)
Calculate N-period spot rate (SN)
ZN)3 = [(1+ f1)(1+f2)…..(1+fN)]1/(N+1) –1
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