WiseAlpha’s educational series: Teaching you everything you need to know about the bond market and more.
We’ve spent some time talking about the basics behind bonds, but what happens when you go to purchase a bond? Here’s the lowdown on accrued interest.
In short, accrued interest is interest that has been accumulated since the last coupon payment date. Earned interest is interest earned for the period that you have physically held the bond.
From the day of issue, bonds and loans begin to accrue interest.The “accrued interest” is the amount of interest the bond has earned but has not yet been paid since the last coupon payment.
When you purchase a bond between coupon dates, the accrued interest is included in the overall amount paid for the bond, but don’t worry you’ll get that back in the next coupon payment and if you’ve decided to reinvest your interest then this will go back into buying more of the investment.
When paying for bonds with accrued interest the amount you have to pay is called the “dirty price”. That means that when you buy a bond or loan, you usually need to pay for some of the accrued interest that’s been racked up since the last coupon payment. Interest is accrued daily so, from the day you buy the bond you are earning interest.
A bond was issued on the 1st of Jan 2017 with a 6% coupon. First coupon payment is expected in 6 months on the 1st July 2017.
Say you bought £1000 of principal of that bond on the 1st of April, halfway between the issue date and the first coupon payment date..
When the coupon is finally paid on the 1 July 2017 you might expect to have earned £15 interest, however you’ll actually get a payment of £30.
So why’s this?
To account for this additional payment of £15 you have to pay the person who sold you the bond on the 1st of April the £15 that they earned which is added to the cost of buying the bond.
WiseAlpha’s making accrued interest easier to understand. As of today you’ll be able to pick how much principal you want to buy, and you’ll see the corresponding accrued interest.
Find out more about investing with WiseAlpha. All factual information true at the time of publishing.
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