Fixed Income Mathematics
Offering explanations, exercises, and examples without demanding sophisticated mathematics, this self-teaching book will serve as a gateway to financial mathematics and to increased competence in business analysis.
TABLE OF CONTENTS Fixed Income Mathematics
Chapter 8: Accrued Interest
You saw in Chapter 6, on bond price calculation, that the bond price equation includes a term for accrued interest and that, for municipal securities, the Municipal Securities Rulemaking Board (MSRB) prescribes a method for calculating accrued interest. That chapter did not consider the actual accrued interest calculation. This chapter considers the various methods of computing accrued interest, when they apply, and to what securities. When you finish this chapter, you should understand the concept of accrued interest, how to compute accrued interest, when it applies in a bond trade, and the different conventions in calculating accrued interest.
WHAT IS ACCRUED INTEREST?
Accruing interest on bond trades is simply a trade custom. A trade does not need to be done in this way. We could simply compute price using the first two terms in the equation given in Chapter 6, and in some countries this is done. In the United States, we add accrued interest to the price, and the buyer pays the total, consisting of two separate parts. For trades done at a dollar price, the accrued interest would be added, and the total becomes the total amount paid. However, the accrued interest could also be included in the bond price. This trade custom probably has a historical basis, possibly dating back for centuries.
Most investors aren t much concerned with calculating accrued interest. Computer programs do this, and the amounts aren t usually very large compared with the principal amount due. However, you should be aware of accrued interest.
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