Accrued Interest
Accrued Interest
Interest that has accumulated on a bond from the last coupon payment date to the settlement date of a trade. The buyer pays the seller accrued interest in addition to the bond's market price. Calculated using the number of days since the last coupon payment, with day count conventions varying by bond type (30/360 for corporates and municipals, actual/actual for Treasuries).
An investor purchases a corporate bond on March 15 with semi-annual coupon payments on January 1 and July 1. The bond pays a 6% annual coupon on $1,000 face value ($30 semi-annually). Settlement occurs March 20, which is 78 days after the January 1 payment (using 30/360 convention: 30 days in Jan + 30 in Feb + 18 in March). Accrued interest = $30 × (78/180 days) = $13. The buyer pays the seller $13 in accrued interest plus the quoted market price.
Students often reverse who pays whom (buyer pays seller, not the other way around), forget that zero-coupon bonds trade flat (without accrued interest since they don't pay periodic interest), or confuse accrued interest with the bond's coupon rate. Accrued interest is owed to the seller for the time they held the bond since the last payment.
How This Is Tested
- Identifying that the buyer pays accrued interest to the seller in a bond transaction
- Calculating accrued interest amount using days since last coupon payment
- Understanding when bonds trade flat (zero-coupon bonds and bonds in default)
- Distinguishing day count conventions for different bond types (30/360 vs actual/actual)
- Determining total settlement amount (quoted price plus accrued interest)
Regulatory Limits
| Description | Limit | Notes |
|---|---|---|
| Corporate/Municipal bond day count | 30/360 convention | Assumes 30 days per month and 360 days per year for calculation simplicity |
| Treasury securities day count | Actual/actual convention | Uses actual calendar days and actual days in the year (365 or 366) |
Example Exam Questions
Test your understanding with these practice questions. Select an answer to see the explanation.
Jennifer purchases a $10,000 face value corporate bond in a secondary market transaction. The bond pays a 5% annual coupon with semi-annual payments on March 1 and September 1. The trade settles on June 15. In addition to the quoted market price, what amount related to interest will Jennifer owe the seller?
C is correct. Jennifer (the buyer) owes the seller accrued interest for the period the seller held the bond since the last coupon payment (March 1 to June 15 settlement). Using the 30/360 convention for corporate bonds, this is 105 days (30 days in March + 30 in April + 30 in May + 15 in June). The semi-annual period is 180 days. Accrued interest = $250 × (105/180) = approximately $177. The seller is entitled to this amount because they held the bond during this period, but Jennifer will receive the full $250 payment on September 1.
A is incorrect because although Jennifer receives the full September 1 payment, she must compensate the seller for their holding period. B is incorrect because Jennifer doesn't owe the full coupon, only the prorated amount for days since the last payment. D reverses the calculation period; buyers pay for the period before settlement, not after.
The Series 65 exam tests understanding of accrued interest mechanics to ensure advisers can explain bond settlement costs to clients. Understanding that buyers compensate sellers for their holding period is fundamental to bond trading and proper disclosure of total investment costs.
In a typical bond transaction, who pays accrued interest and when is it calculated?
B is correct. The buyer pays the seller accrued interest calculated from the last coupon payment date to the trade settlement date. This compensates the seller for the portion of the next coupon payment they earned by holding the bond. When the next coupon payment occurs, the buyer receives the full coupon amount, even though they only held the bond for part of the period. The accrued interest payment settles this fairly.
A incorrectly reverses the direction of payment and the calculation period. C misunderstands the mechanics; the issuer pays the full coupon to whoever owns the bond on the payment date (the buyer), not to both parties. D is incorrect because while the buyer does receive the full next coupon, they must compensate the seller for the portion earned before the trade.
The Series 65 exam frequently tests the fundamental concept of who pays accrued interest. This is essential knowledge for properly calculating total settlement costs and explaining to clients why they pay more than the quoted bond price.
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Access Free BetaA corporate bond with semi-annual coupon payments on March 1 and September 1 is sold with settlement on June 15. The buyer will pay accrued interest calculated from which period?
B is correct. Accrued interest is calculated from the last coupon payment date (March 1) to the settlement date (June 15). This represents the interest the seller earned while holding the bond. The buyer pays this to the seller at settlement, then receives the full next coupon payment on September 1.
A is incorrect because you cannot accrue interest from a future payment date. C is incorrect because accrued interest compensates the seller for the period BEFORE settlement, not after. D is incorrect because it includes the period after settlement when the buyer (not the seller) owns the bond.
Key principle: Buyer pays seller for the seller's holding period, then buyer receives the full next coupon payment covering both the seller's period (reimbursed via accrued interest) and the buyer's period (new income).
Understanding the accrued interest period is essential for Series 65 exam questions about bond settlement. The exam tests whether you know the buyer pays the seller for the period from the last payment to settlement, not the period from settlement to the next payment.
All of the following statements about accrued interest in bond transactions are accurate EXCEPT
C is correct (the EXCEPT answer). Zero-coupon bonds trade flat, which means they trade WITHOUT accrued interest, not that accrued interest is included in the quoted price. Since zero-coupon bonds make no periodic interest payments, there is no coupon to accrue between payment dates. The bond's quoted price reflects the discount from face value based on time to maturity and yield.
A is accurate: the total amount the buyer pays is the quoted (clean) price plus accrued interest, resulting in the "dirty" or "full" price. B is accurate: the buyer receives the entire next coupon payment, which is why they must compensate the seller with accrued interest for the period before they owned the bond. D is accurate: corporate and municipal bonds use the 30/360 convention (assuming 30-day months and 360-day years), while Treasury securities use actual/actual.
The Series 65 exam tests your ability to identify when bonds trade flat (without accrued interest). Zero-coupon bonds and bonds in default are the two main categories that trade flat, which is critical for properly calculating settlement amounts and explaining costs to clients.
An investor sells a Treasury bond between coupon payment dates. Which of the following statements about the accrued interest are accurate?
1. The buyer pays accrued interest to the seller at settlement
2. Accrued interest is calculated using the actual/actual day count convention
3. The accrued interest amount appears separately on the trade confirmation
4. The seller will receive the full next coupon payment from the Treasury
B is correct. Statements 1, 2, and 3 are accurate.
Statement 1 is TRUE: The buyer pays the seller accrued interest at settlement to compensate the seller for interest earned during their holding period. This is standard practice for all coupon-bearing bonds.
Statement 2 is TRUE: Treasury securities use the actual/actual day count convention, meaning actual calendar days in the accrued period divided by actual days in the year (365 or 366), unlike the 30/360 convention used for corporate and municipal bonds.
Statement 3 is TRUE: Trade confirmations must separately disclose accrued interest so investors understand they are paying more than the quoted (clean) price. The total amount (quoted price plus accrued interest) is called the dirty or full price.
Statement 4 is FALSE: The seller will NOT receive the next coupon payment; the BUYER will receive it. The buyer owns the bond on the payment date, so the Treasury pays the full coupon to the buyer. This is why the buyer must pay accrued interest to the seller at settlement to make the transaction fair.
The Series 65 exam tests comprehensive understanding of accrued interest mechanics, including day count conventions specific to different bond types. Understanding that Treasury bonds use actual/actual (not 30/360) is important for accurate calculations and proper client disclosure of settlement costs.
💡 Memory Aid
Think of accrued interest like splitting a restaurant bill for time at the table: The seller (leaving early) earned interest for the time they "sat" at the table (owned the bond), so the buyer (arriving late) pays them for those days. Buyer Pays Seller from last payment to settlement. Key exception: Zero-coupon = Zero accrued (no periodic payments means nothing to accrue). Day count: 30/360 for Corps and Munis, Actual/Actual for Treasuries.
Related Concepts
This term is part of this cluster: