Zero Coupon Curve Construction,

Data Interpolation and FRA calculation

(vincent.chia@tr.com)

Last updated on 5th Nov 2016

Agenda
1. What is a Zero-coupon curve ?

2. How to get indicative data ?

3. Construction of a Zero-coupon curve

4. Introducing ZC Builder

5. Build Zero-coupon curve in Eikon Excel

6. Data Interpolation (Linear or Cubic Spine)

7. Application of Zero-coupon curve

8. FRA (Forward Rate Agreements) Calculation

2 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

What is a

Zero-coupon curve ?
1.1 What is interest rate ?

Price of money across time.

Compounding to Future
FV = PV*(1 + r)

Cashflows $0.9804 Interest rate = 2% $1

Now One year later Time

Discounting to Present
PV = FV / (1 + r)
PV = present value
FV = future vale
r = spot interest rate

4 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

1.2 What is a yield curve ?
Yield Curve, a collection of Interest Rates with the same credit risk.
Zero coupon curve is one of the examples.

Term structure of interest rates

$1*(1+1.2%)3
$1*(1+2.6%)20

now
now
3 years
20 years
-$1
-$1

5 Zero Coupon Curve Construction, Data Interpolation and FRA calculation Yield Curve Model
1.3 Why Zero-coupon curve ?

Zero-coupon curve is an interest rate proxy because it

1. provides a continuous interest rates from T/N (Tom./Next) to, say 30 years.
2. is usually constructed using real time tradable liquid financial instruments.
3. is coupon-free, unburdened by frequency payments of coupons
(e.g. quarterly, semi-annual payment frequency).
……

6 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 1.4.1 What is the main purpose of Zero-coupon rates ?

The main purpose is to price a security (e.g. Bond) by discounting its

cashflows to present with the appropriate interest rates.

yield %
Interbank rates derived
Zero-coupon curve
$(5+100) 4.5332
4.4497

$5 $5 4.2729

Cashflows

Now 1y 2y 3y Time
1y 2y 3y
Term (maturity)
Theoretical Bond Price =

Net Present Value

$5 $5 $(5  100)
$101.3017   
(1  4.2729%)1 (1  4.4497%) 2 (1  4.5332%)3

7 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 1.4.2 Zero Coupon Curve and Discount Factors

yield % Top-View

Term
Interbank rates derived
Zero coupon curve

Price $ Now Time

1 Term
30Y
0.9966

0.8888

Discounting Factors

30Y
0.2140

8 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

Time
 1.4.3 Discounting to Get the Present Value of $1

yield % Top-View

Term

Discount Curve

0.89
Price Now Time
$ 0.89 Term
3Y 30Y

Discounting to
Get Present Value

$1 3Y

30Y

9 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

Time
 1.5 Zero Coupon Curves

yield %
(spot rates)

flattened

“normal”, upwardly sloping

inverted

10y Term
(maturity)

10 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 1.6 Zero Coupon Curve Dynamics
yield %
(spot rates)

Term
On (maturity)
10y
1st Aug 2010
(1st Aug 2020)

On Term
1st Sep 2010 (maturity)
10y
Time (1st Sep 2020)

11 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

1.7 Zero Coupon Rates and Yield-To-Maturity
Theoretical (mark-to-model)
$5 $5 $(5  100)
PStraight_ Bond   
(1  4.2729%)1 (1  4.4497%) 2 (1  4.5332%) 3
$5 $5 $(5  100)
$101.3017   
(1  YTM %)1 (1  YTM %) 2 (1  YTM %) 3

 YTM  4.525%

yield %
Interbank rates derived
4.5332 Zero coupon curve Cashflow weighted
YTM % Average

4.2729

1y 3y Term (maturity)

12 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 1.8 Timeline
Today, T
1 year for zero coupon rates
1 week for zero coupon rates Timeline for Zero Rates
Reuters’ Zero Coupon Curve
based on Act/Act
1 years & start from Trade day
for all tenors.

Spot week (1 week)

Time

T+365
T+2

T+3
T+1

T+9

1 Aug 05 3 Aug 05 10 Aug 05 3 Aug 06

ON TN Typical Timeline for Deposit Rates

ON Over-Night (T) to (T+1)
TN Tomorrow-Night (T+1) to (T+2)
SN Spot Next (T+2) to (T+3)
SW Spot Week (T+2) to (T+9)

13 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

How to get indicative data

on Zero Coupon Rates ?

 2.1 Indicative Data on Interbank rates derived Zero Coupon Rates

The symbol "M" on Zero Coupon Curves such as 0#USDZ=R indicate that the price has moved from the last published value.

As the curves update very frequently, the values published can be the same as the previous values
if the15 Zero Coupon
underlying Curve
interest rate hasConstruction,
not changed. Data Interpolation and FRA calculation
Therefore, we added this qualifier to indicate when there is a price movement, hence the symbol, "M".
Construction of a

Zero Coupon Curve

3.1.1 Construct a Zero Curve from most liquid instruments

Factors to consider :
1. Liquidity (ease of hedging)
2. Real-time (e.g. deposit against Libor Fixings)

yield
(%)
Interbank-rate-derived
Zero Coupon Curve

Term
(maturity)
from from from
Depo-rates I/R Futures Interest Rate Swaps
or
Implied Depos

17 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

3.1.2 The Source for <0#USDZ=R> : <0#USDSOURCE>

18 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 3.2 Construction of Interbank-rate-derived Zero Coupon Curve (< 1 year)

yield %
(spot rates) Interbank-rate-derived
Zero Coupon Curve

SW Term (maturity)
From Money Market, depositON = depositTN=3.3%, depositSW = 3.42% (ask)
For Spot-week (SW)’s “ask”
   
Act
1 1 7
(1  sS / W %) Act
 1  (deposit O / N %) 1  (depositT / N %) 1  (deposit S / W %)
 360  360  360 
   
9
1 1 7
 (1  sS / W %) 366
 1  (3.3%) 1  (3.3%) 1  (3.42%)
 360  360  360 

 sS / W  3.499%

$1*(1 + 3.499%)9/366

O/N T/N S/W

Time
(Trade date+2d) + 7d
-$1 in general
19 Zero Coupon Curve Construction, Data Interpolation and FRA calculation
 3.3.1 Construction of Interbank-rate-derived Zero Coupon Curve (1 ~ 2 years)

yield %
(spot rates) Interbank-rate-derived
Zero Coupon Curve

1y Term (maturity)
From Money Market, depositON = depositTN=3.3%, deposit9m = 4.09% (ask)
Eurodollar mid price = ED9m to 1y (mid) = USD 95.6
    90  100  $ ED9 m to 1 y ,mid  convex9 m to 1 y  
Act
1 1 274
(1  s1Y %) Act
 1  (deposit ON ,ask %) 1  (depositTN ,ask %) 1  (deposit 9 m ,ask %) 1   
 360  360  360   360  100 
    90  100  95.6  0 
366
1 1 274
(1  s1Y %) 366  1  (3.3%) 1  (3.3%) 1  (4.09%)  1   
 360  360  360   360  100 

 s1Y  4.256% 0  convexnearer  convex further 

$1*(1 + 4.256%)366/366

O/N T/N 9m 90d

Time
(Trade date+2d) + 366d
-$1 in general
20 Zero Coupon Curve Construction, Data Interpolation and FRA calculation
3.3.2 Interest Rates Futures, the forward start Zero coupon bond

$100

Trade
date 90d
Time
Spot Implied Yield
date = 100–96 = 4%

-$96

First 6 liquid quarterly International Money Market (IMM)

(Mar,
21
Jun,
ZeroSep, Dec)
Coupon Curve Construction, Data Interpolation and FRA calculation
Interest Rate Futures contracts will be chosen.
 3.4 Construction of Interbank-rate-derived Zero Coupon Curve (> 2 years)

yield %

4.468% $(4.49+100)
4.256%
Interbank-rate-derived Cashflows
Zero Coupon Curve
$4.49 $4.49

1y 2y 3y Term 1y 2y 3y Time

Given fixed rate for mid IRS3 year (mid) = 4.49% or $4.49 for notional of $100

Behave like a 3 year par Bond ,

$4.49 $4.49 $(4.49  100)

$100   
(1  4.256%)1 (1  4.468%) 2 (1  s3 y %) 3

 s3 y  4.494%
This conditions holds only if the payment schedule is the same
as the LIBOR benchmark used & the swap starts on Spot Date.

22 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 3.5.1 Convexity Bias (adjustment) for Interest Rate Futures

Price

Average Price of an
Interest Rate Futures

Unadj. yield yield%

Adj. yield

23 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

3.5.2 Convexity Adjustment Zero Coupon Curve

24 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

3.6.1 Construct a Zero Curve from Govies

Factors to consider :
1. Liquidity (ease of hedging)
2. Real-time

yield
(%)
Interbank-rate-derived
Zero Coupon Curve

Term
(maturity)
from
Govies (Tbills to Tbonds)

25 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 3.6.2 Construction of Bond-derived Zero curve

yield %

4.3% $(2.5+100)
4.256% Govies-derived
4.1% Zero Coupon Curve
$2.5 $2.5 $2.5

6M 1Y 18M 2Y Term 6M 1Y 18M 2Y Time

T-Bond’s coupon = 5%

USD 2.5 USD 2.5 USD 2.5 USD ( 2.5  100)

USD 100  182
 365
 547
 730
(1  4.1%) 365
(1  4.256%) 365
(1  4.3%) 365
(1  s2Y %) 365

s2Y  5.09%

26 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

3.6.3 The Source for <0#USXZ=R> : <0#USXSOURCE>

27 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

3.7 Birdeye View on some USD Zero Coupon Curves

Convexity unadjusted Convexity adjusted

Interbank-rate-derived Bond-derived Interbank-rate-derived
Zero Coupon Rates Zero Coupon Rates Zero Coupon Rates
(from AM3L IRS) (from AM3L IRS)

28 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

3.8 Zero Coupon Yields vs Deposits

Observing,

   
Act
1 1 7
(1  sS / W %) Act
 1  (deposit O / N %) 1  (deposit T / N %) 1  (deposit S / W %)
 360  360  360 
   
9
1 1 7
 (1  sS / W %) 366
 1  (3.3%) 1  (3.3%) 1  (3.42%)
 360  360  360 

 sS / W  3.499%

Ignoring the Overnight & TomNext deposit rates ,

 
Act
7
(1  sS / W %) 1 
Act
(deposit S / W %)
 360 
 Single Period Interest Rates but u sin g different convention.

29 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

ZC Builder :

Zero Coupon Builder

for Eikon’s Calculator

4.1 Activate ZC Builder and choose your preferred instruments

32 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

4.2 Give it a name and Save the customised curve

•c

33 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

4.3 Use it ! For example, in Swap Pricer

34 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

Design Your Own,

with Eikon Excel

5.1 Design your own ZC with Eikon Excel

36 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

5.2 Outcome

37 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

Linear and Cubic Spline

Data Interpolation
6.1 Get Today date with =TODAY() or RtToday()

39 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.2 Calculate the “Maturity” Dates for the Depos

Click “Function” in the Insert pulldown menu.

Proceed to “Adfin Forex & MM” Category,
Choose FxCalcPeriod() call function.

40 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.3 FxCalcPeriod()

Reasons for Adjustment

FxCalcPeriod ( …. ,FROM:MMTRADE RET:3)

Today FxCalcPeriod ( …. ,FROM:MMTRADE RET:4)

(Trade Date)
End Date

Spot Time
Holiday Adjusted
Value Day End Date
(business day)

FxCalcPeriod ( …. ,FROM:MMTRADE RET:1)

FxCalcPeriod ( …. ,FROM:MMTRADE RET:2)

41 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.4 Calculate the “Maturity” Dates for the Depos

Explanation

CalcDate : Reference Date, says, today date.

- type G1 and hit [F4] to lock the
location of this reference data.

Cur1Cur2 : LEFT($A$3, 3),

the first 3 characters of “EURD=“
- type A3 and hit [F4] to lock the
location of this reference data.

Period : the tenor code, example, ON (overnight)

FxMode : “FROM:MMTRADE RET:2”

- calculate from Money Market Trade Date
found in CalcDate parameter.
- return the second answer,
42 Zero Coupon Curve Construction, Data Interpolation andthat
FRA is,
calculation
the maturity date of the depo.
6.5 Calculate the “Maturity” Dates for the Depos

43 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.6 Format the numerical answers to day/month/year format

Simply right click …

44 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.7 Format the numerical answers to day/month/year format

45 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.8 Data Interpolation : Key in a “Broken Date”

46 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.9 Linear Interpolation with AdInterp()

Click “Function” in the Insert pulldown menu.

Proceed to “Adfin Common” Category,
Choose AdInterp() function.

47 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.10 Linear Interpolation with AdInterp()

Deposit Rates %

0.640

0.540

24 May 1 Jun 24 Jun Maturity Dates

48 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.11 Linear Interpolation with AdInterp()

data for XArray : Maturity Dates

data for X : Broken Date

InterpMode IM:LIN

data for YArray : mid values

49 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.12 Cubic Spline Interpolation with AdInterp()

Deposit Rates %

1 Jun Maturity Dates

50 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.13 Cubic Spline Interpolation with AdInterp()

data for XArray : Maturity Dates

data for X : Broken Date

InterpMode IM:CUBR

data for YArray : mid values

51 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.14 Where to get further help or guidance ?

52 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

6.15 The Final Outcome

53 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

Application of

Zero Coupon Rates

7.1 Applications of Zero Coupon Curve

1. To price a security (e.g. Bond)

2. To calculate the swap rate (fixed rate) for any IRS.

3. To derive the Forward Interest Rate Curve.

4. To create the Forward-Rate-Agreement (FRA) instruments.

……

55 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

7.2 Basic Engine : ZC Builder

Swap Pricer Swaption

Caps and Floors

Forward Curve

ZC Builder

Credit Default Swap

56 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

8.1 FRA calculation

57 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

8.2 Starting Date Consideration : Trade or Spot Value ?

Spot
Value Day

Trade Date

58 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

8.3 Illustration with AdDepToFRA()

59 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

9. Conclusion : A Zero Coupon Curve is …

A Zero Coupon Curve is an interest rate proxy because it

1. provides a continuous interest rates from T/N (Tom./Next) to, say 30 years.
2. is usually constructed using real time tradable liquid financial instruments.
3. is coupon-free, unburdened by frequency payments of coupons
(e.g. quarterly, semi-annual payment frequency).
……

60 Zero Coupon Curve Construction, Data Interpolation and FRA calculation

 Questions
&
Answers
61 Zero Coupon Curve Construction, Data Interpolation and FRA calculation