Discount Curve

The table shows the interest rate, the zero rate and the discount factor for each term.

As seen from the graph the zero rate lines above the interest rate curve. This is because the zero rate eliminates the intermediate cash flows and therefore shows the effective rate of interest were you to receive annualised intermediate interest rates.

Why do we calculate zero rates? Zero rates are very useful in instantly calculating the discount factor that reduces the future cash flow to its present value.

It is often used for Bond pricing, pricing complex instruments such as Swaps and for economic forecasting.