Assume that the 1-year interest rate is 4% and the 2-year interest rate is 5%. You approach a bank and ask at what rate the bank will promise to make a 1-year loan in 12 months' time. The bank offers to make a forward commitment to lend to you at 10%. Would you accept the offer? Can you think of a simple, cheaper alternative?

1-year interest rate....................4.00%

2-year interest rate....................5.00%

Forward rate ........................10.00%