Accrued Interest – How It Works For Investments And Debts
Accrued interest refers to the interest that accumulates on a debt instrument such as a bond, loan or savings account, over a specified period of time.
It represents the growth in the value of the debt due to the accumulation of interest over a period of time.
For example, if a bond pays an annual interest rate of 5% and is held for 6 months, the accrued interest would be 2.5% of the bond’s face value. This means that the bondholder is entitled to receive interest income on the debt for the 6 months that the bond has been held.
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How Accrued Interest Works For Borrowers And Lenders
Accrued interest is important for both the borrower and the lender.
For the borrower, it is a cost that increases the amount owed on the loan or bond.
For the lender, it is a source of income that increases the return on their investment.
In the bond market, accrued interest is considered a liability for the issuer and an asset for the bondholder.
When a bond is bought or sold, the buyer must pay the seller an amount equal to the accrued interest.
This is known as the “dirty price” of the bond and includes both the face value of the bond and the accrued interest.
Similarly, in the loan market, accrued interest is considered a liability for the borrower and an asset for the lender.
Accrued interest is usually added to the principal amount of the loan and becomes part of the total debt owed by the borrower.
In the case of savings accounts, accrued interest refers to the interest earned on the balance in the account. Banks usually calculate the interest on a daily or monthly basis and credit the account with the accumulated interest at the end of the period.
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