A funding curve can be explained as being a line joining a set of known interest rate points on a graph,
with time time being represented on the X-axis, and interest rates on the Y.
There are three broad types of funding curves :
The simplest type of funding curve, normally only used to represent interest rates going out to a maximum
of 5 or 10 years.
It is made up of known money-market rates such as 3, 6, and 9-month T-bill rates, etc.
2. Swap curves
Swap curves also use money-market rates to extrapolate the curve in the short term, but then use both
quarterly-forward and swap rates to extend the curve further into the future.
3. Bond and "Real" curves
Like swap curves, bond curves also use money-market rates to extrapolate the curve in the short term, but
not normally beyond six months to a year.
From this point bond rates are used to generate the curve, often up to 30 or 40 years in the future.
The generation of a bond curve is somewhat more complex than that of money-market and swap curves.
The curve is "bootstrapped" from the each bond using an iterative process to allow for the fact that each
bond has a different coupon-rate.
Methodology used to generate the curves :
1. All curves must have an overnight rate to "anchor" the curve at the start.
2. The entered short-term, quarterly forward and swap rates are all converted to NACC (normal annually compounded continuous)
rates before extrapolating, to ensure that the rates are like-for-like.
3. There is a simple "left to right" rule governing the prioritising of the different rate type inputs into the curves if there is an overlap.
For the swap curves, a money market rate will "overrule" a FRA rate, and a FRA rate will "overrule" a swap rate within the period.
For example if you enter a 1 year effective rate, and a 5x8 FRA rate then the FRA rate will be ignored.
For bonds, if the term of the money market rate is longer than that of the bond, the bond rate will be ignored.
For example if you enter a 4 year money-market rate as well as a string of bonds from 2 out to 10 years, then only those bonds maturing
after 4 years will be computed in the creation of the curve.
4. All fundingcurves.com curves are "unadjusted". ie : They do NOT take into account public holidays or weekends.
For example if a known 30-day rate is actually on a Sunday or public holiday, it will not be moved to the previous
or next business day. (This is to ensure there are no anomalies when overlaying funding curves from different countries)