Accrued interest on bonds refers to the amount of interest that has accumulated on a bond since the last interest payment was made, but has not yet been paid to the bondholder.
When buying bonds on the secondary market, the buyer will have to pay accrued interest to the seller as part of the total purchase price.
The secondary market for bonds is where investors can buy and sell bonds that have already been issued, as opposed to the primary market where bonds are initially issued by entities like governments or corporations.
This article will cover the following topics:
- How are coupon payments distributed on bonds with accrued interests?
- How are accrued interests on bonds calculated?
- Where can I view accrued interests?
- Example
How are coupon payments distributed on bonds with accrued interests?
Only the registered bondholder can receive the coupon payment, but the investor who sold the bond must be compensated for the period during which he held the bond. In other words, the previous owner must receive all the interest accrued prior to the sale.
The interest paid on a bond is compensation for the money the investor lends to the bond issuer. This borrowed money is called the principal. The principal amount will be repaid to the bondholder at maturity. Whoever is the rightful owner of the bond at maturity will receive the principal amount. If the bond is sold on the market before maturity, the seller will receive the bond's market value.
The accrued interest adjustment therefore corresponds to the additional amount of interest paid to the owner of a bond. The amount paid is equal to the balance of interest accrued since the bond's last payment date.
How are accrued interests on bonds calculated?
The formula for calculating accrued interests:
- AI = t / T * PMT
- AI = Accrued interests
- t = Days since the last coupon payment
- T = Days in the coupon payment period
- PMT = Coupon value of each period
There are two methods for counting the number of days in a coupon payment period ( T ) and the days since the last coupon period ( t ) :
- The first is the actual number of days in the period / actual number of days in the year, which is generally used for U.S. Treasury bonds and bills.
- The second is the 30/360 convention, which assumes 30 days for a month and 360 days for a year, usually used for corporate bonds.
Where can I view accrued interests?
You can view accrued coupons in different places on your platform:
- Portfolio > Transactions > click on the Bonds transaction
- Portfolio > click on the button with [. . .] on the right end of the position > Position details
Please note that you will also have the estimated accrued interest on your transaction tickets before you validate the transactions.
- When opening a trade ticket for a bond trade, you are able to view any accrued interest before placing an order as shown below:
When buying bonds, you pay the Market value, Accrued interest and Trade fees when opening a trade.
Example
Accrued coupon payments on the secondary market
A Treasury bond with a par value of $1,000 at a coupon rate of 6% paid semi-annually. The last coupon payment was made on March 31, and the next payment will be made on September 30, giving a period of 183 days.
The coupon payment for each period is $30 ([6%/2] * $1,000).
If a trader buys the bond on May 31, the accrued interest will be $10 ($30 * [61/183]) using the day-counting convention: actual number of days in the period / actual number of days in the year.
The first bondholder is eligible for the coupon on his holding period (March 31 to May 30), but since he sells the bonds during the period, he will not be paid on September 30.
As a result, the bond buyer will pay him the pro rata amount, i.e. $10. Our buyer will receive $30 in coupons on September 30 (i.e. 100% of the coupons), but he was not the owner of the bonds for the entire period, which is why he paid the seller an additional $10 when he bought them.