Question 1

Why do I have to pay accrued interest when buying a bond?

Accepted Answer

The seller held the bond and is entitled to interest for their holding period. When the next coupon is paid, it goes entirely to you (the new owner), even though some was earned by the seller. Paying accrued interest compensates them fairly. You'll recoup this when you receive the full coupon.

Question 2

Is accrued interest taxable?

Accepted Answer

Yes, when you receive the coupon, you'll owe tax on the full amount. However, the accrued interest you paid when buying can be used to reduce your taxable interest income. Keep purchase statements for tax reporting. Some bonds have specific tax treatment.

Question 3

What happens to accrued interest on the coupon date?

Accepted Answer

On the coupon payment date, accrued interest resets to zero. The coupon is paid to whoever owns the bond on the record date (usually a few days before payment). The cycle then starts again, with interest accruing daily until the next coupon.

Question 4

How does accrued interest affect bond yields?

Accepted Answer

Accrued interest affects your actual cash outlay but not yield calculations. Yield to maturity is based on clean price. However, your actual return depends on the full price paid. When comparing bonds, use clean prices for yields but remember your true cost includes accrued interest.

Question 5

What is negative accrued interest?

Accepted Answer

In ex-coupon periods, the bond trades without the right to the next coupon. The buyer doesn't receive the upcoming payment, so accrued interest effectively becomes negative - the seller compensates the buyer. This is more common in some international markets.

Question 6

Does day-count convention significantly affect accrued interest?

Accepted Answer

Yes, it can make a material difference, especially for longer accrual periods. 30/360 assumes equal months; Actual/Actual uses real calendar days. The difference can be several dollars per $1,000 face value. Always use the convention specified for the bond type.

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