the first set of rates are simple rates (money market). These are used to calculate discount factors as follows:df = 1/(1 + R*T) where R is the rate and the T is the time in years.the annually compounded rates are obtained from the above discount factors as follows:df = (1+r)^-T where r is the annually compounded rate. The choice of annual compounding is arbitrary - other compounding can and is often used. if semi-annual compounding was used then df = (1+r/2)^(-2T) and so on.once you have a set of rates, you can then use these to calculate forward rates.the forward rate for period 1,2 is obtained as follows:df(0,1) * df(1,2) = df(0,2)hence df(1,2) = df(0,2)/df(0,1)for points along the curve where you do not have an explicit rate obtained from money market instruments, then you can just interpolate.for example, taking the 6 into 6 forward rate the forward discount factor is 0.973047/0.986777 which is 0.986085. This gives a forward annual compounding rate of 2.8421%.hth
Last edited by daveangel
on March 31st, 2008, 10:00 pm, edited 1 time in total.
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