[Sorry, technical preamble, scroll down if not interested...]
Accrued interest is a notional value, i.e. it's not a real thing paid by any issuer, it is just a quantity calculated using the value of the coupon and number of days to expected payment. There are two purposes to this notional accrued interest value:
1. to back out the fluctuation of price every 3/6/12 months due to the expectation and eventual payment of coupons and to leave a smoother underlying price which theoretically is only subject to non-interest fluctuations. This aids analysis and comparison of bonds, especially those of the same issuer and when coupons are large in relation to price.
2. to allow easy calculation of allowances or payments of income tax required to HMRC under the so-called Accrued Income Scheme. When you sell a bond you are required to declare the present value of the next coupon included in the price you paid to the purchaser and pay tax on that "income" (as it is deemed to be). Conversely, when you buy a bond you are permitted to deduct the amount of the accrued income and not pay income tax on it.
When it comes to actually trading the share these are the conventions you'll find in the market:
-If the bond is not in default then the price as listed by brokers and most data sources will be a "clean price" (i.e. with the accrued interest backed out).
-When you come to get a quote there will usually also be a clean price quoted with the accrued interest value also explicitly quoted, or occasionally a dirty price (i.e. the full value of the bond without the accrued interest backed out) will be quoted. Broker commission/fees will also be quoted to give the total amount payable to/receivable from the broker.
-The contract note you receive will usually calculate and show the accrued interest. This is usually the value you should put in your tax return but note that when a bond has defaulted the broker amount is often not correct and you have to calculate the accrued income based on the particular circumstances. [A current example is WBS (West Bromwich PIBS) which is quoted dirty, and only partial coupons are being paid so traders have to calculate the accrued income themselves based on the next actual coupon amount paid after purchase/sale. The tax rules are laid out in the Accrued Income Scheme documentation.]
-An explicit accrued interest payment is never made to or received from anyone, it is just an imagined part of the total value of the bond.
BTW, share prices in contrast to bonds are always quoted similar to dirty bond quotes i.e. the value of the anticipated dividend is always included in the quoted price, so that there is a step change in the price at the ex-payment date.
Securevalue wrote:I will be buying through a third party, say Hargreaves Lansdown
Right now the buy price is 101.50
So if i bought 10k bonds it would cost £10,150
Would i therefore qualify for the full 9.625% (£962.50)
Or would Hargreaves Lansdown somehow reduce my coupon payment to reflect only holding the bond for a month
Appreciate your help
So for this specific bond, the price quoted is of course a clean price. The actual price you should pay at purchase is the full price including accrued interest. The latter will be calculated as the value of the future payment at the day you purchase so of course will include most of the value of the final coupon.
Thus you will receive the full coupon at maturity but will have paid most of its value at purchase, and your actual return from owning this bond is likely to be very small or even negative if your purchase price is too high.
It's an unfortunate fact that usually it is more trouble to trade a bond close to maturity than is worth in any potential return.
GS
