Forward Rates The forward rate is determined by no-arbitrage: ft(n - 1) = [1 + ye(n)]" Pt(n - 1) [1 + ye (n - 1) ]n-1 - 1 P.(n) " Example with n=2 (and rewriting) (1 + ye(2)) = [(1 + ye(1))(1 + ft(1))]2 " Forward rate = interest rate that would need to prevail in second year to make the long- and short- term investments equally attractive. You can read off the 1-year forward interest rate from today's prices of the 1-year zeros and the two-year zero. Derivation in technical note 4 DIY " The yield on the 8 year bond is 3.8% " The yield on the 7 year bond is 4% Find the (one-year) forward rate starting 7 years from now. What if the yield on the 8 year bond is 6%? 9