2.10.6. Accrued Interest
Most bonds are quoted at a “clean price,” which means the quoted price does not include interest, but then most are traded at a “dirty price,” which includes any interest that has accrued on the bond from the date interest was last paid until the day before the settlement date. Often, a bond trader will quote the clean price and add the words “and interest,” to indicate that whatever interest has accrued will be added to the clean price. The settlement date is the date that buyers are expected to pay for the securities they purchased and sellers are expected to deliver the securities they sold. For most securities settlement is two business days after the trade date or T + 2. This is called regular way settlement.
Accrued interest is added to the amount of the buyer’s sales confirmation because the buyer must pay the price of the security plus the added interest. Accrued interest is also added to the amount on the seller’s confirmation because he receives the price of the security plus the accrued interest.
For calculating interest on corporate bonds, each month is assumed to have 30 days, and a year is assumed to have 360 days. A 30-day month and 360-day year are not assumed for all types of bonds, however. For example, a Treasury bond assumes the actual days of the month and the actual days in the year. See the table below for the conventions of different types of bonds.
Example Question
Sheila has just sold her XYZ 5% bond. The bond last paid interest on February 1st and she sold it on Monday, May 15. How much accrued interest should Sheila receive?
Answer: $14.72
Explanation: Sheila’s bond will settle on May 17. The bond last paid interest on February 1, so she will receive 30 days for February, 30 days for March, 30 days for April, and 16 days for May. This is 106 days total. Divide 106 by 360 days to calculate the fraction of annual interest Sheila is due: 106/ 360 = 0.2944. Then calculate the am