Accrued Interest
Quick Answer
Accrued interest is interest that an interest-bearing security has earned but that has not yet been paid to the investor. In bond markets, it commonly builds between scheduled coupon payments and may form part of the amount exchanged when a bond is bought or sold between payment dates.
How does accrued interest work?
Many bonds pay interest at scheduled intervals rather than every day. However, the economic entitlement to that interest builds during the period between payments.
FINRA explains that bond interest accrues between regularly scheduled payments and that accrued interest adds up during the period after the last coupon payment and before the next one.
When a bond changes ownership between coupon dates, the seller may be entitled to the portion of the upcoming interest payment that accumulated while they held the bond. The buyer may therefore pay an amount representing that accrued interest as part of settlement.
A simplified calculation is:
Accrued interest = periodic coupon payment × proportion of the coupon period that has elapsed
Where
Input A — what it means
Input B — what it means
Example
Replace with a short worked numeric example.
The exact calculation depends on the security and its applicable day-count convention, which defines how days are counted for interest purposes. FINRA's calculator, for example, uses a 360-day year for corporate and municipal bonds and a 365-day year for government bonds.
Key features of accrued interest
Several characteristics help explain accrued interest in fixed-income markets:
Earned but unpaid: Investor.gov defines accrued interest as interest earned on a security but not yet paid to the investor.
Builds between payment dates: For coupon-paying bonds, the amount generally increases as time passes after the previous coupon payment.
Connected to coupon payments: A bond coupon specifies the interest due and the date on which it is paid.
May affect settlement: When eligible bonds trade between coupon dates, accrued interest may be due to the seller for the portion of interest earned before settlement.
Calculation conventions differ: Bond types may use different methods for counting the days used in the calculation.
Simple accrued interest example
Suppose a bond has a $1,000 face value and pays a 6% annual coupon in two equal semiannual payments.
Annual interest:
$1,000 × 6% = $60
Each semiannual coupon:
$60 ÷ 2 = $30
Assume half of the six-month coupon period has elapsed when the bond is sold. Using a simplified proportional calculation:
$30 × 50% = $15 accrued interest
The buyer may therefore compensate the seller for approximately $15 of accrued interest in addition to the relevant bond price.
This example is illustrative only. Actual accrued-interest calculations depend on the security's payment schedule, settlement date and applicable day-count convention.
Potential benefits and uses
Understanding accrued interest may help market participants:
distinguish interest already earned from the next scheduled coupon payment;
understand why the settlement amount for a bond can differ from its quoted price;
compare bond transactions taking place at different points in a coupon period;
reconcile interest amounts shown in transaction records or statements.
Accrued interest is primarily an accounting and settlement concept. It does not increase a bond's contractual coupon rate or guarantee an investment return.
Risks, limitations and common misconceptions
A common misconception is that accrued interest represents an extra return paid to a bond buyer. In a secondary-market transaction, it may instead compensate the seller for interest earned before the buyer acquired the bond.
Another misunderstanding is that all bonds use the same accrued-interest formula. Day-count conventions and settlement rules can differ between securities and markets, so a simplified calculation may not reproduce the actual transaction amount.
Accrued interest also should not be confused with compound interest. Investor.gov defines compound interest as interest paid on principal and accumulated interest, whereas accrued interest refers to interest already earned but not yet paid.
Finally, accrued interest does not remove credit, interest-rate, liquidity or other risks associated with holding a bond.