Deriving the Forward Curve
Step 9: Deriving forward rates
In order to derive forward rates from the zero coupon rates for successive interest rate periods the bootstrapping methodology has been employed. In particular the following formula has been used:
Where t is the tenor in years, ZC_{t} is the zero coupon rate for a tenor of t years and FC_{t-1,t} is the forward rate for the period (t-1,t).
For example, the forward rate for the interest rate period 3 years to 4 years using zero coupon rates is
The forward rates are as follows is our example:
t | FC_{t-1,t} |
1 | 12.150% |
2 | 12.405% |
3 | 12.643% |
4 | 12.525% |