TABLE OF CONTENTS

INTRODUCTION ..................................................................................................... 1

TABLE OF CONTENTS ........................................................................................... 2

CHAPTER I: PRELIMINARY .................................................................................. 3

BACKGROUND ..................................................................................... 3

FORMULATION OF PROBLEM .......................................................... 3

PURPOSE ............................................................................................... 3

CHAPTER II: CONTENTS ....................................................................................... 4

BASIC CONCEPTS ................................................................................ 4

BOOTSTRAPPING ................................................................................ 4

AN ADVANCED METHODOLOGY: THE CUBIC B-SPLINE .......... 5

MATHEMATICAL TOOLS................................................................... 9

CHAPTER III: CLOSING .........................................................................................15

CONCLUSION .......................................................................................15

BIBLIOGRAPHY ......................................................................................................16

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 CHAPTER I

PRELIMINARY

BACKGROUND

For market practitioners, zero-coupon rate curves are the basic tools used to
value interest-rate based instruments. Curves are built using market data such as
money market rates, swap rates, interest rates futures or bond prices as inputs.
Despite the name, it is not in fact the ‘zero coupon’ rates that are the most important
output from a curve fitting methodology, but rather a set of quantities known as
discount factors. It is these that are crucial for the pricing of interest rate-based
instruments.

In this chapter, we provide an advanced methodology to extract discount

factors from a set of bond prices. The objective is to be as explicit as possible so that
nonmathematicians may be able to incorporate the methodology into their daily
activity.

FORMULATION OF THE PROBLEM

1. How is the basic concept of B-Spline Modelling and Fitting the Term
Structure?
2. What are the methodologies and how to use each of them?

PURPOSE

1. To understand the basic concept of B-Spline Modelling and Fitting the Term
Structure.

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2. To understand the methodologies.

CHAPTER II

CONTENTS

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5
6
7
8
9
10
11
12
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 CHAPTER III

CLOSING

CONCLUSION

We have described an advanced methodology by which one can extract a

zerocoupon curve from market-observed bond prices. It is more reliable than the
classic bootstrapping methodology as it smoothes the discount curve, and therefore
the zero-curve, thanks to its B-spline definition. More importantly, it results in more
realistic forward rates.

We also described the basic tools, that is, B-splines and the optimisation
method, so that non-mathematicians should be able to implement this methodology
without undue complication and perhaps on their own.

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BIBLIOGRAPHY

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