Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which two spot interest rates are needed to find the value of a six-month forward contract from a six-month T-bill?

1. Current six-month and 12-month spot rates

2. Three-month and six-month spot rates

3. Current three-month and one-year spot rates

4. Current long-term and short-term spot rates

The correct answer is: Current six-month and 12-month spot rates

To determine the value of a six-month forward contract from a six-month T-bill, it is crucial to understand the relationship between spot rates and forward contracts. Forward contracts are affected by the interest rates prevailing at the time of the contract initiation as well as at the contract's maturity. The current six-month spot rate provides the interest rate applicable to funds invested over the first six months. The 12-month spot rate, on the other hand, reflects the interest rate applicable for a longer term, which complements the short-term perspective by indicating rates for the subsequent six months after the initial investment. Together, these two spot rates are essential for calculating the price of the forward contract. Using both the current six-month and 12-month spot rates allows for the appropriate discounting of cash flows: the six-month rate for the immediate yield and the 12-month rate for the period extending into the future. This consideration is fundamental in accurately pricing and valuing forward contracts, which hinge on the time value of money. In comparison, other potential combinations of spot rates would not adequately reflect the necessary periods for determining the forward contract's value. For instance, utilizing a three-month spot rate alongside the six-month rate would not provide insight into the complete six-month duration required