Constructing Yield Curve

In general we don’t have all the data points that needed to construct a yield curve because there is only fixed number of products in the market with varying coupon frequencies. So a yield curve is constructed by plotting yield to maturities of zero coupon bonds for short term and zero coupon rates derived from long term fixed coupon bonds. Deriving zero coupon rates from a long-term bond is called bootstrapping. To put it in clear terms, the first few values of yield curve are directly available as 1 year, 2 year zero coupon bonds are available in the market. Assume a 3 year zero coupon bond is not available in the market. The yield of a 3 year zero coupon bond can be derived from a 10 year bond by the method of bootstrapping and these values are used to construct yield curve. The explanation of bootstrapping is out of scope under this article as it’s a complex process.