Topic: Spot and Forward Rates
You are given the following spot interest rate curve:
t rt
0.25 0.030
0.50 0.035
0.75 0.039
1.00 0.042
1.25 0.045
1.50 0.047
1.75 0.049
2.00 0.050
Using the above spot interest rates, calculate the present value of an annuity immediate with
three semi-annual payments. The first payment is 1000 in six months. The second payment is
2000 in one year. The final payment is 3000 in 18 months.
Solution:
PV = 1000(1 + r0.5 ) −0.5 + 2000(1 + r1 ) −1 + 3000(1 + r1.5 ) −1.5
= 1000(1.035)−0.5 + 2000(1.042)−1 + 3000(1.047)−1.5
= 5702.61
1
You are given the following spot interest rate curve:
t rt
0.5 0.020
1.0 0.026
1.5 0.031
2.0 0.035
2.5 0.039
3.0 0.042
3.5 0.045
4.0 0.048
4.5 0.051
5.0 0.054
Use the spot interest rates to calculate the accumulated value of an annuity due with payments
of 24,000 at the beginning of each year for 3 years.
Solution:
First, we find the present value, then we find the accumulated value.
PV = 24, 000(1 + (1 + r1 ) −1 + (1 + r2 ) −2 )
= 24, 000(1 + (1.026) −1 + (1.035) −2 )
= 69, 796.07
AV = PV (1 + r3 )3 = 69,796.07(1.042)3 = 78,964.91
2
You are given the following spot interest rate curve:
t rt
0.5 0.020
1.0 0.026
1.5 0.031
2.0 0.035
2.5 0.039
3.0 0.042
3.5 0.045
4.0 0.048
4.5 0.051
5.0 0.054
Use the spot interest rates to calculate the price of two year par value bond with a maturity
value of 10,000. The bond pays semi-annual coupon at a rate of 8% convertible semi-annually.
Solution:
0.08
Semi-annual Coupon = Fr = 10, 000 = 400
2
Price = PV = 400(1 + r0.5 ) −0.5 + 400(1 + r1 ) −1 + 400(1 + r1.5 ) −1.5 + 10, 400(1 + r2 ) −2
= 400(1.02)−0.5 + 400(1.026)−1 + 400(1.031)−1.5 + 10, 400(1.035) −2
= 10,876.53
3
You are given the following three bonds:
a. A one year bond which sells for 990 and has a maturity value of 1000 and annual
coupons of 42.
b. A two year bond with a maturity value of 50,000 and annual coupons of 10,000. The
price of this bond is 61,000.
c. A three year zero coupon bond with a maturity value of 100,000 which sells for 77,000.
Use bootstrapping to find f[1,3] .
Solution:
First, we need to find the spot rates using bootstrapping. Then, using the spot rates, we
will find the forward rate.
1042 1042
Price of A = 990 = ==> r1 = − 1 = 0.052525253
1 + r1 990
10, 000 60, 000
Price of B = 61, 000 = +
1 + r1 (1 + r2 )2
1
60, 000 10, 000 60, 000 2
= 61, 000 − = 51, 499.04 r = 51, 499.04 − 1 = 0.079384202
(1 + r2 ) 2
2
1.052525253
1
10, 000 100, 000 3
Price of C = 77, 000 = ==> r3 = − 1 = 0.091029328
(1 + r3 )
3
77, 000
1
(1 + r3 )3 2
(1 + r1 )(1 + f[1,3] ) 2 = (1 + r3 )3 ==> f[1,3] = −1
1 + r1
1
(1.091029328)3 2
f[1,3] = − 1 = 0.110806405
1.052525253
4
Luke can buy the following two bonds:
a. Bond A is a one year bond with a price of 1020. The bond has annual coupons of 90 and
a maturity value of 1000.
b. Bond B is a two year bond with a maturity value of 10,000. The bond has annual
coupons of 700. The price of the bond is 9900.
Based on these two bonds, determine f[1,2] .
(Hint: Use bootstrapping to find the spot rates and then find the forward rate.)
Solution:
First, we need to find the spot rates using bootstrapping. Then, using the spot rates, we
will find the forward rate.
1090 1090
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐴 = 1020 = ⇒ 𝑟1 = − 1 = 0.068627451
1 + 𝑟1 1020
700 10,700
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐵 = 9900 = +
1 + 𝑟1 (1 + 𝑟2 )2
10,700 700 10,700 0.5
= 9900 − = 9244.95 ⇒ 𝑟2 = ( ) −1
(1 + 𝑟2 )2 1.068627451 9244.95
= 0.075819739
(1 + 𝑟2 )2 (1.075819739)2
𝑓[1,2] = −1= − 1 = 0.083060434
1 + 𝑟1 1.068627451
5
You are given the following spot interest rates:
t rt t rt
0.5 5.00% 3.0 6.60%
1.0 5.40% 3.5 6.85%
1.5 5.75% 4.0 7.05%
2.0 6.05% 4.5 7.20%
2.5 6.35% 5.0 7.30%
Grigor is receiving an annuity immediate with two annual payments of 10,000.
Using the spot interest rates, you determine the present value of the annuity. You then
determine the equivalent annual yield rate on the annuity.
What was the annual yield rate that you determined?
Solution:
𝑃𝑉 = 10,000(1 + 𝑟1 )−1 + 10,000(1 + 𝑟2 )−2 = 10,000(1.054)−1 + 10,000(1.0605)−2
𝑃𝑉 = 18,379.24018
We want to find 𝑖 , the annual yield rate.
18,379.24018 = 10,000 a2
Use your calculator to find 𝑖 :
N ← 2 ; PV ← 18,379.24018 ; PMT ← −10,000
CPT I / Y ← 5.824018766%
6
You are given the following spot interest rates:
t rt t rt
0.5 4.00% 3.0 5.85%
1.0 4.50% 3.5 6.20%
1.5 4.95% 4.0 6.35%
2.0 5.30% 4.5 6.45%
2.5 5.60% 5.0 6.50%
Determine the price of a 2 year bond with semi-annual coupons of 200 and a maturity value of
3000.
Solution:
P = PV = (200)(1.04) −0.5 + (200)(1.045) −1 + (200)(1.0495) −1.5 + 3200(1.053) −2
= 3459.50
7
You are given the following spot interest rates:
t rt t rt
0.5 4.00% 3.0 5.85%
1.0 4.50% 3.5 6.20%
1.5 4.95% 4.0 6.35%
2.0 5.30% 4.5 6.45%
2.5 5.60% 5.0 6.50%
Tianjian invested 10,000 today and another 10,000 at the end of two years.
How much will Tianjian have at the end of four years?
Solution:
First, find the present value using the spot rates.
PV = 10, 000 + 10, 000(1.053)−2 = 19, 018.68582
Then AV = PV (1.0635)4 = 24,329.35
8
You are given the following spot interest rate curve:
t rt
0.5 1.25%
1.0 2.00%
1.5 2.75%
2.0 3.20%
2.5 3.60%
3.0 4.00%
Using these spot interest rates, determine the price of a 2 year bond that matures for 100,000
and has semi-annual coupons of 5000.
Solutions:
PV = 5000(1.0125)−0.5 + 5000(1.02)−1 + 5000(1.0275)−1.5 + 105, 000(1.032)−2
= 113, 260.95
9
You are given the following spot interest rates:
t rt t rt
0.5 3.00% 3.0 4.85%
1.0 3.50% 3.5 5.20%
1.5 3.95% 4.0 5.35%
2.0 4.30% 4.5 5.45%
2.5 4.60% 5.0 5.50%
Determine the present value of an annuity immediate with semi-annual payments for two years.
The payments increase each payment. The first payment is 100. The second payment is 200.
The third payment is 400. The final payment is 800.
Solution:
PV = 100(1.03)−0.5 + 200(1.035)−1 + 400(1.0395)−1.5 + 800(1.043)−2
= 1404.58
10
You are given the following spot interest rates:
t rt t rt
0.5 3.00% 3.0 4.85%
1.0 3.50% 3.5 5.20%
1.5 3.95% 4.0 5.35%
2.0 4.30% 4.5 5.45%
2.5 4.60% 5.0 5.50%
Determine the accumulated value of an annuity due that pays 1000 at the beginning of each
year for 3 years.
Solution:
First, we find the present value and then find the accumulated value.
PV = 1000(1 + (1.035)−1 + (1.043)−2 ) = 2885.43
AV = PV (1.0485)3 = 3325.95
11
You are given the following two bonds:
a. Bond 1 is a one year zero coupon bond with a price of 9400 and a maturity value of
10,000.
b. Bond 2 is a two year bond with annual coupons of 300 and a maturity value of 2000.
This bond sells for an annual yield of 8%.
You are also given that the three year spot interest rate is 9%.
Determine the price of a three year bond with annual coupons of 800 and a maturity value of
3000.
Solution:
Using Bond 1
10, 000 10, 000
9400 = == r1 = − 1 = 0.063829787
1 + r1 9400
Using Bond 2
300 2300 300 2300 300 2300
+ = + == + = 2249.66
1 + r1 (1 + r2 ) 1.08 (1.08)
2 2
1.063829787 (1 + r2 )2
2300
r2 = − 1 = 0.081158118
300
2249.66 −
1.063829787
800 800 3800 800 800 3800
Price = + + = + + = 4370.70
1 + r1 (1 + r2 ) (1 + r3 ) 1.063829787 (1.081158118) (1.09)3
2 3 2
12
You are given the following spot interest rates:
Time (t) rt
0.5 2.1%
1.0 2.3%
1.5 2.6%
2.0 3.0%
2.5 3.3%
3.0 3.7%
3.5 4.2%
4.0 4.8%
4.5 5.5%
5.0 6.0%
Megan purchases a two year par value bond with semi-annual coupons at a rate of 8%
convertible semi-annually. The par value of the bond is 10,000.
Calculate the price of the bond.
Solution:
Coupon = (10, 000)(0.08 / 2) = 400
400 400 400 10, 400
P= 0.5
+ 1
+ 1.5
+ = 10,974.76
(1.021) (1.023) (1.026) (1.03) 2
13
The following three bonds are priced using the same spot interest rates:
a. Bond A is a one year bond with a maturity value of 1000, annual coupons of 70, and a
price of 1005.
b. Bond B is a two year bond with annual coupons of 200 and a maturity value of 1000. It
sells to yield an annual effective interest rate of 8%.
c. Bond C is a three year bond with annual coupons of 270. The maturity value and the
price of the bond are 3000.
Kristin has a three year annuity immediate with annual payments of 1000. Using the same spot
interest rates, determine the accumulated value of Kristin’s annuity.
Solution:
First we need to find the spot rates using bootstrapping. Then, using the spot rates, we
will find the present value of the annuity. Finally, we will find the accumulated value
of the annuity.
1070 1070
= 1005 == r1 = − 1 = 0.06467662
1 + r1 1005
200 1200 1 − (1.08) −2 −2
+ = Price of B = 200a + 1000v 2
= 200 + 1000(1.08) = 1213.99
1 + r1 (1 + r2 ) 2 2
0.08
0.5
1200 200 1200
= 1213.99 − = 1026.14 == r2 = − 1 = 0.081402
(1 + r2 ) 2
1.06467662 1026.14
270 270 3270 3270 270 270
+ + = 3000 == = 3000 − − = 2515.5202
1 + r1 (1 + r2 ) (1 + r3 )
2 3
(1 + r3 ) 3
1.06467662 (1.081402)2
1/3
3270
r3 = − 1 = 0.091373
2515.5202
1000 1000 1000 1000 1000 1000
PV = + + = + + = 2563.64
1 + r1 (1 + r2 ) (1 + r3 ) 1.06467662 (1.081402) (1.091373)3
2 3 2
AV = PV (1 + r3 )3 = (2563.64)(1.091373)3 = 3332.55
14
You are given:
a. f[0,1] = 0.05
b. f[1,2] = 0.06
c. f[2,3] = 0.07
d. f[3,4] = 0.08
Calculate the price of a zero coupon bond that matures for 100,000 at the end of four years.
Solution:
100, 000
P= = 77, 749.45
(1.05)(1.06)(1.07)(1.08)
15
You can buy the following three bonds:
i. A six month zero coupon bond with a maturity value of 1000 and a price of 970.
ii. A one year bond with semi-annual coupons of 100 and a maturity value of 1000.
The price of the bond is 1130.
iii. A bond that matures in 18 months with semi-annual coupons of 400 and a
maturity value of 800. The price of this bond is 1845.
Determine the spot rate for 18 months.
Solution:
Using Bond i:
970(1 + r0.5 )0.5 = 1000 == r0.5 = 0.062812201
Using Bond ii:
1100
1130 = 100(1 + r0.5 )−0.5 + 1100(1 + r1 )−1 == r1 = − 1 = 0.064859632
1130 − 100(1.062812201)−0.5
Using Bond iii:
1845 = 400(1 + r0.5 )−0.5 + 400(1 + r1 )−1 + 1200(1 + r1.5 ) −1.5
1845 = 400(1.062812201)−0.5 + 400(1.064859632)−1 + 1200(1 + r1.5 ) −1.5
1/1.5
1200
r1.5 = −0.5 −1
− 1 = 0.071864
1845 − 400(1.062812201) − 400(1.064859632)
16
You are given the following three bonds:
a. A one year bond with annual coupons of 100 and a maturity value of 1000. The bond
has a price of 1050.
b. A two year bond with annual coupons of 80 and maturity value of 1000. The bond has a
price of 990.
c. A three year bond with annual coupons of 200 and a maturity value of 800. The price of
this bond is 1065.
Use bootstrapping to determine the three year spot interest rate.
Solution:
Using one year bond:
1100
1050 = 1100(1 + r1 )−1 == r1 = − 1 = 0.047619
1050
Using two year bond:
990 = 80(1 + r1 ) −1 + 1080(1 + r2 ) −2 = 80(1.047619)−1 + 1080(1 + r2 )−2
0.5
1080
== r2 = −1
− 1 = 0.087239
990 − 80(1.047619)
Using three year bond:
1065 = 200(1 + r1 ) −1 + 200(1 + r2 )−2 + 1000(1 + r3 )−3 =
200(1.047619)−1 + 200(1.087239)−2 + 1000(1 + r3 )−3
1/3
1000
== r3 = −1 −2
− 1 = 0.123633
1065 − 200(1.047619) − 200(1.087239)
17