In finance, bootstrapping is a method for constructing a (zero-coupon) fixed-income yield curve from the prices of a set of coupon-bearing products, e.g. bonds and swaps.
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.
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).
Note that some analysts will instead construct the curve such that it results in a best-fit "through" the input prices, as opposed to an exact match, using a method such as Nelson-Siegel.
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.
therefore (this formula is precisely forward substitution) After the financial crisis of 2007–2008 swap valuation is typically under a "multi-curve and collateral" framework; the above, by contrast, describes the "self discounting" approach.