What is a 'Range Accrual'

A range accrual, or range accrual note, is a type of financial derivative product where the earning, or accrual, of the coupon rate, depends on the value of an index. The index could be an interest rate, currency exchange rate, the price of a commodity or stock index. If the index value falls within a specified range, the coupon accrues or is credited, interest. If the index value falls outside the specified range, the coupon rate does not accumulate.

Other names include for this derivative include accretion bond index range note, corridor bond,  corridor note, range floater, and a fairway bond.

BREAKING DOWN 'Range Accrual'

The investor holding the range accrual security desires the index to stay within a specified range from the range accrual's issuance to its maturity. This strategy is a bet on stability or low volatility in the index market, as well as an investment in the note. Because, the cash flow is not guaranteed, the stated coupon rate is often higher. For investors believing the index market will not move as fast as, perhaps a yield curve, futures contango or geopolitical news might imply, it is a way to enhance the yield.

Because it has a fixed coupon rate, a range accrual qualifies as fixed-income security, but realistically in name only. Another name for the coupon is a conditional coupon since its yield payment depends on another event or condition. The payment calculation timeframe is usually daily. Since actual interest payments can be zero for any given return calculation period, real income is not necessarily fixed. 

No official market exists for range accrual notes trading or valuation. Valuations become even trickier with range accruals which include call features and dual range accruals. A dual range accrual is one which uses two indexes, for example, based on an exchange rate and interest rate.

Calculating a Range Accrual

Range accrual notes start with the same calculations used on any fixed-income security, matched with the payment period. Payment periods may be monthly, semi-annually or annually. The inclusion a "yes or no" type of modifier is the main difference between the securities.

Let's say the investor holds a 3% coupon, one-year note with a monthly payout in January. The index base for the security is the price of crude oil trading in New York, with a range between $60.00 and 61.00 per barrel. Further, assume that crude oil traded in that price range for 15 of the 31 days of the month.

  • 3.00% * 15/31 * 1/12 = 0.121%

The interest payment made on February 1 would be 1.45% times the principal value divided by 12.

Repeat the calculation for all other months.

For February, payable on March 1, with the index within range for 20 days, it would be as follows:

  • 3.00% * 20/28 * 1/12 = 0.179%

Annualized monthly payments range from 0 to a maximum of 3.00%.

If the index remains in range the entire month:

  • 3.00% * 1 *1/12 = 0.250% 
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