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The general methodology is as follows: (1) Define the set of yielding products - these will generally be coupon-bearing bonds; (2) Derive discount factors for the corresponding terms - these are the internal rates of return of the bonds; (3) 'Bootstrap' the zero-coupon curve, successively calibrating this curve such that it returns the prices ...
Forward Discount Rate 60% 40% 30% 25% 20% Discount Factor 0.625 0.446 0.343 0.275 0.229 Discounted Cash Flow (22) (10) 3 28 42 This gives a total value of 41 for the first five years' cash flows. MedICT has chosen the perpetuity growth model to calculate the value of cash flows beyond the forecast period.
Smith, A. and Wilson, T. (2000). Fitting Yield Curves with Long Term Constraints. Research report, Bacon & Woodrow. Technical documentation of the methodology to derive EIOPA's risk-free interest rate term structures
Discount Rate: The cost of capital (Debt and Equity) for the business. This rate, which acts like an interest rate on future Cash inflows, is used to convert them into current dollar equivalents. This rate, which acts like an interest rate on future Cash inflows, is used to convert them into current dollar equivalents.
In the case where the only discount rate one has is not a zero-rate (neither taken from a zero-coupon bond nor converted from a swap rate to a zero-rate through bootstrapping) but an annually-compounded rate (for example if the benchmark is a US Treasury bond with annual coupons) and one only has its yield to maturity, one would use an annually ...
When the yield curve is flat, the capital gain is predicted to be much less, and there is little variability in the bond's total returns over time. As market rates of interest increase or decrease, the impact is rarely the same at each point along the yield curve, i.e. the curve rarely moves up or down in parallel.