According to some textbooks, to derive the yield curve, quote
- overnight to 1 week: rates from interbank money market deposit,
- 1 month to 1 year: LIBOR;
- 1 year to 7 years: Interest Rate Swap;
- 7 years above: government bond.
I'm a bit lost here: how can an IRS rate be used to derive yield curve?
Yield rate is the discount rate, if $ yield (5 years) = 4.1 \% $ , it means the NPV of 1 dollar 5 years later is $ NPV ( 1 dollar, 5 years) = 1/[(1+4.1\%)^5] = 0.818 $.
While interest rate swap is a contract among to legs. Assume a 5 years' IRS contract is
- leg A pays fixed rate to B @ 8.5%, while A receives floating rate @ LIBOR +1.5%
- leg B pays floating rate to A @ LIBOR +1.5%, B receives fixed rate@ 8.5%.
, how could this swap contract help deriving the 5 years' yield rate?