Bootstrapping

Fama and Bliss (1987)
Constant Forward Rates (CFR)
It assumes a constant forward rate between successive bond maturities.

Bootstrapping spot rates is a forward substitution method
Spot rates obtained using bootstrapping are called Implied Spot Rates

Each of these instruments has a market price that can be retrieved from a Data Provider.
Each of these instruments also has a theoretical price that is a function of both forward rates and discount factors.

The bootstrapping method uses interpolation to determine the yields for Treasury zero-coupon securities with various maturities. Using this method, a coupon-bearing bond is stripped of its future cash flows - that is, coupon payments - and converted into multiple zero-coupon bonds. Typically, some rates at the short end of the curve will be known. For rates that are unknown due to insufficient liquidity at the short end, you can use inter-bank money market rates.

To recap, first interpolate rates for each missing maturity. You can do this using a linear interpolation method. Once you have determined all the term structure rates, use the bootstrapping method to derive the zero curve from the par term structure. It is an iterative process that makes it possible to derive a zero-coupon yield curve from the rates and prices of coupon-bearing bonds.

When the yield curve is plotted using data on the yield and maturities of on-the-run Treasuries, it is referred to as an interpolated yield curve or I curve. On-the-run Treasuries are the most recently issued U.S. Treasury bills, notes, or bonds of a particular maturity.

Choose Market Instruments

either Government Bonds or LIBOR/Swap

Define Prioritisation

because of market imperfections, liquidity

Create the Curve

Interpolation

The Zero Coupon Curve is typically only known with certainty for a few specific maturity dates.
To obtain the yield curve for any maturity date interpolation methods can be used.

Linear Interpolation

Extrapolation

Calibrate and Validate

normally using the same instruments you used for the bootstrapping
benchmark testing

Different Bootstrap Methods

Linear Swap Rates (LSR)

Original Linear Forward Rates (LFR)
Enhanced Linear Forward Rates (LFR2)
Quadratic Forward Rates (QFR)