A:

A bond represents a debt obligation whereby the owner (the lender) receives compensation in the form of interest payments. These interest payments, known as coupons, are typically paid every six months. During this period the ownership of the bonds can be freely transferred between investors. A problem then arises over the issue of the ownership of interest payments. Only the owner of record can receive the coupon payment, but the investor who sold the bond must be compensated for the period of time for which he or she owned the bond. In other words, the previous owner must be paid the interest that accrued before the sale.

The interest paid on a bond is compensation for the money lent to the borrower, or issuer, this borrowed money is referred to as the principal. The principal amount is paid back to the bondholder at maturity. Similar with the case of the coupon, or interest payment, whoever is the rightful owner of the bond at the time of maturity will receive the principal amount. If the bond is sold before maturity in the market the seller will receive the bond's market value.

For example, suppose investor A purchases a bond in the primary market with a face value of $1,000 and a coupon of 5% paid semi-annually. After 90 days, investor A decides to sell the bond to investor B. The amount investor B has to pay is the current price of the bond plus accrued interest, which is simply the regular payment adjusted for the time investor A held the bond. In this case, the bond would be $50 over the entire year ($1,000 x 5%), and investor A held the bond for 90 days which is almost a quarter of the year, or 24.66% to be exact (calculated by 90/365). So, the accrued interest ends up being $12.33 ($50 x 24.66%). So investor B will have to pay investor A the value of the bond in the market, plus $12.33 of accrued interest.

For more in-depth reading, see our tutorial on Bond Basics, as well as the chapter Bond Pricing in our Advanced Bond Tutorial.)

RELATED FAQS
  1. How does the money from the interest on my bond get to me?

    When you buy a regular coupon bond, you are entitled to a coupon, which is typically paid at regular intervals, and the face ... Read Answer >>
  2. Do long-term bonds have a greater interest rate risk than short-term bonds?

    The answer to this question lies in the fixed income nature of bonds and debentures, often referred to together simply as ... Read Answer >>
  3. If I buy a $1,000 bond with a coupon of 10% and a maturity in 10 years, will I receive ...

    Simply put: yes, you will. The beauty of a fixed-income security is that the investor can expect to receive a certain amount ... Read Answer >>
  4. What are the key factors that will cause a bond to trade as a premium bond?

    Learn about the primary factor that can cause bonds to trade at a premium, including how national interest rates affect bond ... Read Answer >>
  5. How does an investor make money on bonds?

    Bonds are part of the family of investments known as fixed-income securities. These securities are debt obligations, meaning ... Read Answer >>
Related Articles
  1. Financial Advisor

    Using Excel PV Function to compute Bonds PV

    To determine the value of a bond today - for a fixed principal (par value) to be repaid in the future at any predetermined time - we can use an Excel spreadsheet.
  2. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  3. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  4. Investing

    Understanding Bond Prices and Yields

    Understanding this relationship can help an investor in any market.
  5. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  6. Investing

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  7. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  8. Investing

    How Does A Bond’s Coupon Interest Rate Affect Its Price?

    All bonds come with a coupon interest rate, which is the fixed annual interest a bond pays.
  9. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  10. Investing

    Risks To Consider Before Investing In Bonds

    Make sure you understand the risks associated with bonds before making an investment decision.
RELATED TERMS
  1. Flat Bond

    A debt instrument that is sold or traded without accrued interest, ...
  2. Bond

    A debt investment in which an investor loans money to an entity ...
  3. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  4. Coupon Rate

    The yield paid by a fixed income security. A fixed income security's ...
  5. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  6. Coupon Bond

    A debt obligation with coupons attached that represent semiannual ...
Hot Definitions
  1. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  2. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  3. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
  4. Hard Fork

    A hard fork (or sometimes hardfork) is a radical change to the protocol that makes previously invalid blocks/transactions ...
  5. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  6. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
Trading Center