A dirty price refers to the cost of a bond that includes the accrued interest based on the coupon rate. Bond price quotes between coupon payment dates reflect the accrued interest up to the day of the quote.
In essence, a dirty bond price **includes accrued interest **while a clean price does not.
Key Takeaways
- A dirty price includes accrued interest along with a bond’s coupon payment.
- When a bond is quoted between coupon payment dates, the price cited includes accrued interest up to the day of the quote.
- Clean quotes are common in the United States, while dirty quotes are standard in Europe.
Grasping the Concept of Dirty Price
Accrued interest is the interest earned when a coupon bond is currently in between coupon payment dates. As the next coupon payment date approaches, the accrued interest increases each day until the payment of the coupon. On the day of the coupon payment, the clean price and dirty price are equal since there is no accrued interest until the next market day.
The dirty price, sometimes called the price plus accrued, allows a seller to calculate the actual cost of a bond since the bond might have accrued interest from the previous coupon payment date. Thus, the date of the sale would reflect the clean price plus any accrued interest, calculated daily. As a result, a buyer’s actual price paid for the bond is higher than the quoted price on financial websites because it accounts for the accrued interest and the broker’s commission.
Accumulating Accrued Interest
The interest increases steadily on a bond and the accrued amount is calculated daily. Therefore, the dirty price will change every day until the payout or coupon payment date. Once the payout is complete and the accrued interest resets to zero, the dirty and clean prices are identical.
For bonds offering semiannual payments, the dirty price would rise slightly higher each day over six months. Once the six-month mark arrives and the coupon payment is made, the accrued interest resets to zero to begin the cycle again. This dirty-to-clean process continues until the bond reaches maturity.
Dirty Vs. Clean Pricing
The dirty price is typically quoted between brokers and investors, whereas the clean price, or the price without accrued interest, is usually considered the published price. Newspapers or financial resources tracking prices generally reflect the clean price. Although the dirty price includes accrued interest, the clean price is often regarded as the bond’s value in the current market.
Real-World Example of a Dirty Price
Consider this example: Apple Inc. issues a bond with a $1,000 face value, while $960 is the published price. The bond pays an interest rate (coupon rate) of 4% annually, with payments semiannually. As a result, investors receive $20 every six months for holding the bond.
The $960 is the clean price. However, an investor wishing to purchase the bond would receive a quote from a broker that includes the $960 plus any accrued interest. The broker calculates the daily per diem of interest that has accumulated. Assume there’s no broker commission. Depending on the purchase day, the accrued interest varies.
If the investor buys the bond a day before the first coupon payment of $20, it results in $19 of accrued interest up to that date. Therefore, the bond’s total price for the investor would be $979, which is $960 plus $19 in accrued interest.
Related Terms: Clean Price, Coupon Bond, Investment Strategies.
