You may have heard the term accrued interest when considering a bond. But what does this mean for your portfolio?
Bonds earn interest income every day. However, they pay interest only on their regular interest payment dates (monthly, quarterly or semiannually). On any given day between interest payment dates, bonds have earned a certain amount of interest that hasn’t yet been paid – this is the accrued interest.
You can calculate accrued interest by multiplying a bond’s coupon interest rate by the number of days that have passed since the last interest payment date. Typically, the days are calculated based on a 360-day year and 30-day months. For example, if you own $10,000 worth of bonds paying 4% interest semiannually on June 1 and Dec. 1, you would receive $200 on each interest payment date. But what would be your accrued interest for these bonds on Sept. 1?
Whether you’re buying or selling, it’s important to remember another investor is always on the other side of the transaction. If you’re the seller, you receive the bonds’ current market price as well as the accrued interest up to the settlement date of the trade. If you’re the buyer, you pay the bonds’ market price in addition to any accrued interest earned since the last interest payment date. This ensures both parties receive the amount of interest they are owed.
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