Risk free rate: Interest rate which has no risk of loss. For risk free rate risk is zero. Calculate the forward risk free rate as follows: Forward rate = Risk free rate + Average inflation Given one year inflation rate is 1.4%, year two inflation rate is 1.8% and 2% after year 2. Assume the real risk free rate is 3%.

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Chapter 5, Problem 12PROB

Summary Introduction

Risk free rate:

Interest rate which has no risk of loss. For risk free rate risk is zero.

Calculate the forward risk free rate as follows:

Forward rate=Risk free rate+Average inflation

Given one year inflation rate is 1.4%, year two inflation rate is 1.8% and 2% after year 2. Assume the real risk free rate is 3%.

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