Lecture

Estimating the Term Structure: Bootstrapping Example

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Description

This lecture covers the bootstrapping method, widely used in trading desks, to build the term structure from short to long maturities using US market data on LIBOR, futures, and swaps. It explains the process of deriving discount curves and swap rates through linear interpolation, resulting in a detailed analysis of the discount curve and implied forward curve. The instructor demonstrates how bootstrapping ensures exact market price reconstruction, crucial for interest rate risk management and trading desks.

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Related concepts (30)

Interest rate swap

In finance, an interest rate swap (IRS) is an interest rate derivative (IRD). It involves exchange of interest rates between two parties. In particular it is a "linear" IRD and one of the most liquid, benchmark products. It has associations with forward rate agreements (FRAs), and with zero coupon swaps (ZCSs). In its December 2014 statistics release, the Bank for International Settlements reported that interest rate swaps were the largest component of the global OTC derivative market, representing 60%, with the notional amount outstanding in OTC interest rate swaps of

381 trillion, and the gross market value of

14 trillion.

Yield curve

In finance, the yield curve is a graph which depicts how the yields on debt instruments – such as bonds – vary as a function of their years remaining to maturity. Typically, the graph's horizontal or x-axis is a time line of months or years remaining to maturity, with the shortest maturity on the left and progressively longer time periods on the right. The vertical or y-axis depicts the annualized yield to maturity. Those who issue and trade in forms of debt, such as loans and bonds, use yield curves to determine their value.

Linear interpolation

In mathematics, linear interpolation is a method of curve fitting using linear polynomials to construct new data points within the range of a discrete set of known data points. If the two known points are given by the coordinates and , the linear interpolant is the straight line between these points. For a value in the interval , the value along the straight line is given from the equation of slopes which can be derived geometrically from the figure on the right. It is a special case of polynomial interpolation with .

Interpolation

In the mathematical field of numerical analysis, interpolation is a type of estimation, a method of constructing (finding) new data points based on the range of a discrete set of known data points. In engineering and science, one often has a number of data points, obtained by sampling or experimentation, which represent the values of a function for a limited number of values of the independent variable. It is often required to interpolate; that is, estimate the value of that function for an intermediate value of the independent variable.

Bilinear interpolation

In mathematics, bilinear interpolation is a method for interpolating functions of two variables (e.g., x and y) using repeated linear interpolation. It is usually applied to functions sampled on a 2D rectilinear grid, though it can be generalized to functions defined on the vertices of (a mesh of) arbitrary convex quadrilaterals. Bilinear interpolation is performed using linear interpolation first in one direction, and then again in another direction.

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