Introduction to Bootstrapping

Bootstrapping: Calculation of theoretical spot rate curve from a par yield curve    

 

This educational publication is the special valuation series on fixed income securities. Its mandatory to read the Understanding Term Structure of Interest Rates posted under Insights here before reading Bootstrapping: Calculation of theoretical spot rate curve from a par yield curve. 

There are multiple ways in which a theoretical spot rate curve can be derived from the par yield curve of Treasury securities. Some of them involve advanced statistical analysis while stripping coupon securities into zero-coupon bonds is not the best way to derive yield due to tax distortions. The most popular way is to use on the run treasury securities along with selected of the run treasury securities called Bootstrapping. US treasury frequently issued treasuries are Treasury Notes: 2, 5 & 10 and 30-year long term bonds. This leaves a lot of gaps that need to be filled through off-the run treasuries. One simple method is to use the linear interpolation method between two securities of different maturities. However, this method oversimplifies yields of securities which lie between two maturities. 

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