Building a Yield Curve
Financial institutions use yield curves (also called discount curves) to calculate the present value of all future cash flows (positive or negative) coming from the financial instruments held on the firm’s balance sheet. The purpose of discounting future cash flows comes from the concept of the time value of money. Cash is not a static investment. It grows by earning interest or loses value by being charged interest as borrowed money. The process of discounting includes this nonstatic behavior. Yield curves are needed for multiple currencies because interest rates vary from country to country. One can also have more than one yield curve for a specific currency (e.g., a US Treasury curve versus a US LIBOR curve).