Hi

Spot, Forward, and Par Rates

For those who are using Mock Book Version “A & B”, you might have the following questions missing which is given
below.
Question
1. Assume we observe the following (unrealistically) steep swap rate curve:

This swap rate curve implies semi-annual discount factors and spot rates. Which is nearest to the implied 1.5-year
effective annual spot rate; i.e., the 1.5-year semi-annual spot rate implied by the swap rate curve translated into
an effective annual rate (EAR, aka, effective annual yield)?
A. 2.925%
B. 3.000%
C. 3.019%
D. 3.042%
1. Correct Answer: D
Per Tuckman's bootstrap approach (Tuckman Chapter 1):
100 = d (0.5) *100.40 --> d (0.5) = 100/100.40 = 0.9960159
100 = d (0.5) *1.10 + d (1.0) *101.10 --> d (1.0) = [100 – d (0.5) *1.10]/101.10 = 0.9782827
100 = d (0.5) *1.50 + d (1.0) *1.5 + d (1.5) *101.50 --> d (1.5) = [100 – d (0.5) *1.50 -
D (1.0) *1.5]/101.50 = 0.9560448
So the implied discount factors are:
 0.9960159 at 0.5 years,
 0.9782827 at 1.0 years, and
 0.9560448 at 1.5 years.
Therefore, the 1.5-year spot rate = [(1/0.9560448) ^ (1/3)-1] *2 = 3.01926% with semi-annual compounding; such
that the EAR = (1+3.01926%/2) ^2 - 1 = 3.042050%. Alternative, we can just use the 1.5-year discount rate:
(1/0.9560448) ^ (1/1.5) - 1 = 3.042050%

Happy Studying!!