 Not to be confused with Bootstrapping (corporate finance).
In finance, bootstrapping is a method for constructing a (zerocoupon) fixedincome yield curve from the prices of a set of couponbearing products, e.g. bonds and swaps.[1]
A bootstrapped curve, correspondingly, is one where the prices of the instruments used as an input to the curve, will be an exact output, when these same instruments are valued using this curve. Here, the term structure of spot returns is recovered from the bond yields by solving for them recursively, by forward substitution: this iterative process is called the bootstrap method.
The usefulness of bootstrapping is that using only a few carefully selected zerocoupon products, it becomes possible to derive par swap rates (forward and spot) for all maturities given the solved curve.
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✪ FRM Part I Concept of Bootstrapping Fixed Income

✪ LINGO: Bootstrapping

✪ Bootstrapping Video 2
Transcription
Contents
Methodology
Analytic Example:
Given: 0.5 year spot rate, Z1 = 4%, 1 year spot rate, Z2 = 4.3% (we can get these rates from TBills which are zerocoupon, and serve as discount factors). We then use these rates to calculate the 1.5 year spot rate. Then, say, e.g. 1.5 year bond selling at Par, coupon = 4.5%, semiannual. We solve the 1.5 year spot rate, Z3, by the formula below: We solve for which is the 1.5 year spot rate. 
As stated above, the selection of the input securities is important, given that there is a general lack of data points in a yield curve (there are only a fixed number of products in the market). More importantly, because the input securities have varying coupon frequencies, the selection of the input securities is critical. It makes sense to construct a curve of zerocoupon instruments from which one can price any yield, whether forward or spot, without the need of more external information.[2] Note that certain assumptions (e.g. linear interpolation) will always be required.
General methodology
The general methodology is as follows: (1) Define the set of yielding products  these will generally be couponbearing bonds; (2) Derive discount factors for the corresponding terms  these are the internal rates of return of the bonds; (3) 'Bootstrap' the zerocoupon curve, successively calibrating this curve such that it returns the prices of the inputs. A generically stated algorithm for the third step is as follows; for more detail see Yield curve#Construction of the full yield curve from market data. For each input instrument:
 solve analytically for all zerorates where this possible (see sidebar example)
 iteratively solve for other rates (initially using an approximation) such that the price of the instrument in question is exactly made output when calculated using the curve
 once solved, save these rates, and proceed to the next instrument.
When solved as described here, the curve will be arbitrage free in the sense that it is exactly consistent with the selected prices; see Rational pricing#Fixed income securities and Bond valuation#Arbitragefree pricing approach. Note that some analysts will instead construct the curve such that it results in a bestfit "through" the input prices, as opposed to an exact match, using a method such as NelsonSiegel.
Regardless of approach, however, there is a requirement that the curve be arbitragefree in a second sense: that all forward rates are positive. More sophisticated methods for the curve construction — whether targeting an exact or a bestfit — will additionally target curve "smoothness" as an output,[3][4] and the choice of interpolation method here, for rates not directly specified, will be important.
Forward substitution
A more detailed description of the forward substitution is as follows. For each stage of the iterative process, we are interested in deriving the nyear zerocoupon bond yield, also known as the internal rate of return of the zerocoupon bond. As there are no intermediate payments on this bond, (all the interest and principal is realized at the end of n years) it is sometimes called the nyear spot rate. To derive this rate we observe that the theoretical price of a bond can be calculated as the present value of the cash flows to be received in the future. In the case of swap rates, we want the par bond rate (Swaps are priced at par when created) and therefore we require that the present value of the future cash flows and principal be equal to 100%.
therefore
(this formula is precisely forward substitution)
 where
 is the coupon rate of the nyear bond
 is the length, or day count fraction, of the period , in years
 is the discount factor for that time period
 is the discount factor for the entire period, from which we derive the zerorate.
Recent practice
Post the financial crisis of 2008 swap valuation is typically under a "multicurve" framework; the above, by contrast, describes the "self discounting" approach. The reason for the change is that postcrisis, the overnight index swap rate is considered a better proxy than Libor for the "riskfree rate", and "OISdiscounting" is now standard (sometimes, referred to as "CSAdiscounting".) The result is that, in practice, curves are built as a "set" and not individually: "forecast curves" are constructed for each floatingleg LIBOR tenor; and discounting is on a single, common OIS curve which must simultaneously be constructed. See Interest rate swap § Valuation and pricing for the math, and for context, Financial economics § Derivative pricing.
See also
 Yield curve#Construction of the full yield curve from market data
 Fixedincome attribution#Modeling the yield curve
 Lattice model (finance)#Interest rate derivatives; discussing short rate "trees", constructed using an analogous approach.
References
 William F. Sharpe; Gordon J. Alexander; Jeffery V. Bailey (1998). Investments. Prentice Hall International. ISBN 013011507X.
 John C. Hull (2009). Options, futures and other derivatives (seventh edition). Pearson Prentice Hall. ISBN 9780136015864.
External links
 Excel Bootstrapper, janroman.dhis.org
 Bootstrapping StepByStep, bus.umich.edu