Accrued Interest

What Is Accrued Interest?

Accrued interest is the accumulated interest on a bond since the last coupon payment date. When a bond changes hands between payment dates, the buyer must compensate the seller for the interest earned during their holding period. This payment is made in addition to the quoted market price and ensures fair compensation between buyer and seller.

The concept exists because bond coupons are paid on fixed dates (typically semiannually), but bonds can trade on any business day. Without accrued interest, the economics of trading between coupon dates would be distorted.

Why It Matters for Markets

Accrued interest is central to the distinction between clean price and dirty price in bond markets. The clean price (also called the flat price or quoted price) is the market price without accrued interest. The dirty price (also called the full price or invoice price) includes accrued interest and represents the actual amount the buyer pays at settlement.

Bond markets quote clean prices because they remove the day-to-day drift caused by accruing interest, making it easier to compare prices and assess value across bonds. However, the dirty price is what actually changes hands at settlement and is the relevant price for calculating actual investment returns.

For portfolio managers, accrued interest represents a receivable that must be tracked for accurate portfolio valuation. At any point in time, a bond portfolio's total value includes the market value of the bonds (clean prices) plus all accrued interest. Ignoring accrued interest would understate the portfolio's true value.

Day-Count Conventions

Different bond markets use different conventions for counting the days in the accrued interest calculation. The most common are:

30/360: Assumes 30-day months and 360-day years. Used for U.S. corporate and municipal bonds. Simplifies calculations but does not match actual calendar days.

Actual/Actual: Uses real calendar days in both the numerator and denominator. Used for U.S. Treasury bonds. More precise but requires knowing the exact number of days in each coupon period.

Actual/360: Uses actual days elapsed but assumes a 360-day year. Common in money markets. These conventions can produce slightly different accrued interest amounts for the same bond, making it important to apply the correct convention for each bond type.