Fixed income
Accrued interest
Accrued interest represents the interest that has accumulated on a bond or other debt instrument since the last interest payment date but has not yet been paid to the bondholder. It’s essentially the portion of interest that the bondholder has earned up to a specific date.
Here's how it works:
1. Interest payment schedule
Most bonds pay interest periodically, such as semiannually or annually. Between these payment dates, interest accrues daily based on the bond’s coupon rate.
2. Calculation for transactions
When a bond is sold between interest payment dates, the buyer owes the seller the accrued interest, as the seller owned the bond for part of the period and is entitled to that portion of interest earned. The bond price includes this accrued interest.
3. Importance in yield calculations
Accrued interest is critical in determining a bond's yield because it affects the bond's total purchase price and, consequently, the return for the investor.
In short, accrued interest is a mechanism that ensures fair compensation for the interest earned between payment dates whenever a bond changes hands.