Interpolation is a methodology of guessing what the value would be in between 2 points.

Linear interpolation assumes that between the 2 points is a straight line.

Lets have a look at an example:

Suppose we know the Zero Rate for 1 year: 3% We also know the 4y Zero Rate: 8% ... how do we calculate the 2 year Zero Rate ?

Here's how our data looks in Excel

The formula we use is: =C4+(C5-C4)*(E4-B4)/(B5-B4)

Which translates to: Take the first rate, and add a proportion of the difference of the first rate and the second rate.

- That proportion is calculated by how close we are to the second rate. It's often good to view Interpolation on a graph so that it becomes clearer what we're doing:

- So clearly, all we're doing is drawing a straight line between 2 points, and Linear Interpolation gives us the value for a point in between the 2 points.

Download Spreadsheet to look at Interpolation in Excel

Training Video on Linear Interpolation: