4.3.2. Accrued Interest Payment
Municipal bonds pay interest semiannually. When an investor purchases a bond in the secondary market, interest has already been accumulating since the last coupon payment. This accrued interest is added to the purchase price of the bond. Why? Let’s have a look.
Example: Adrian buys a block of Detroit 5% GO bonds (face value $50,000) on Friday, June 21. Because the settlement date is two business days after the trade date (T + 2), this means that Adrian’s trade will settle on Tuesday, June 25. On July 1 he is due to receive a semiannual interest payment of $1,250, which has been accumulating since January 1. Most of this accrued interest has been earned by the previous owner, who will feel cheated if the new owner receives interest for the entire period. To compensate the seller, Adrian must add to the purchase price of the bonds all the interest that has accrued up to, but not including, the settlement date.
Accrued interest for municipal bonds is calculated in the same way as corporate bonds, which assume a 360-day year and 30-day month (the 30/360 convention). Accrued interest is calculated from the last coupon date up to, but not including, the settlement date of