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Definition of 'Accrual Bond': Sinking Fund (Formula) Handout

An accrual bond does not make periodic interest payments. Instead, interest accrues and is added to the principal over time. When the bond reaches a certain point, it will begin paying out both the principal and accrued interest. Accrual bonds have greater interest rate risk than bonds that make regular payments. A sinking fund provision requires an issuer to periodically repurchase a portion of outstanding bonds, reducing debt over time. This provides safety for investors by lowering the amount owed at maturity, while also allowing the issuer to replace debt at lower rates if rates decline. The dirty price of a bond includes any accrued interest, while the clean price does not. Immediately after an interest payment, the dirty and clean

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48 views3 pages

Definition of 'Accrual Bond': Sinking Fund (Formula) Handout

An accrual bond does not make periodic interest payments. Instead, interest accrues and is added to the principal over time. When the bond reaches a certain point, it will begin paying out both the principal and accrued interest. Accrual bonds have greater interest rate risk than bonds that make regular payments. A sinking fund provision requires an issuer to periodically repurchase a portion of outstanding bonds, reducing debt over time. This provides safety for investors by lowering the amount owed at maturity, while also allowing the issuer to replace debt at lower rates if rates decline. The dirty price of a bond includes any accrued interest, while the clean price does not. Immediately after an interest payment, the dirty and clean

Uploaded by

Katrina Vianca Decapia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Definition of 'Accrual Bond'

A bond that does not pay periodic interest payments. Instead, interest is added to the principal
balance of the bond and is either paid at maturity or, at some point, the bond begins to pay both
principal and interest based on the accrued principal and interest to that point.

Investopedia explains 'Accrual Bond'

When the bond begins to pay both principal and interest based on the accrued principal and
interest at that point, this is known as a Z tranche and is common in collateralized mortgage
obligations (CMOs). In a CMO that includes a Z tranche, the interest payments that otherwise
would be paid to the Z-tranche holder is used to pay down the principal of another tranche. After
that tranche is paid off, the Z tranche begins to pay down based on the original principal of the
tranche plus the accrued interest.

Similar to a zero-coupon bond, an accrual bond or Z tranche has limited or no reinvestment risk.
However, accrual bonds, by definition, have a longer duration than bonds with the same maturity
that make regular interest or principal and interest payments. As such, accrual bonds are subject
to greater interest rate risk than bonds that make periodic payments over their entire terms.

Sinking Fund (formula) handout

Investopedia explains 'Sinking Fund'

Rather than the issuer repaying the entire principal of a bond issue on the maturity date, another
company buys back a portion of the issue annually and usually at a fixed par value or at the
current market value of the bonds, whichever is less. Should interest rates decline following a
bond issue, sinking-fund provisions allow a firm to lessen the interest rate risk of its bonds as it
essentially replaces a portion of existing debt with lower-yielding bonds.

From the investor's point of view, a sinking fund adds safety to a corporate bond issue: with it,
the issuing company is less likely to default on the repayment of the remaining principal upon
maturity since the amount of the final repayment is substantially less. This added safety affects
the interest rate at which the company is able to offer bonds in the marketplace.

Definition of 'Clean Price'


The price of a coupon bond not including any accrued interest. A clean price is the discounted
future cash flows, not including any interest accruing on the next coupon payment date.
Immediately following each coupon payment, the clean price will equal the dirty price.

Calculated as:

Definition of 'Dirty Price'

A bond pricing quote referring to the price of a coupon bond that includes the present value of all
future cash flows, including interest accruing on the next coupon payment. The dirty price is how
the bond is quoted in most European markets, and is the price an investor will pay to acquire the
bond.

Investopedia explains 'Dirty Price'

Accrued interest is earned when a coupon bond is currently in between coupon payment dates.
As the next coupon payment date approaches, the accrued interest increases until the coupon is
paid. Immediately following the coupon payment, the clean price and dirty price will be equal.

The dirty price is sometimes called the "price plus accrued". The clean price is quoted more often
in the United States.

\Definition of 'Call Provision'


A provision on a bond or other fixed-income instrument that allows the original
issuer to repurchase and retire the bonds. If there is a call provision in place, it
will typically come with a time window under which the bond can be called, and
a specific price to be paid to bondholders and any accrued interest are defined.

Callable bonds will pay a higher yield than comparable non-callable bonds.
Investopedia explains 'Call Provision'

A bond call will almost always favor the issuer over the investor; if it doesn't, the issuer will
simply continue to make the current interest payments and keep the debt active. Typically, call
options on bonds will be exercised by the issuer when interest rates have fallen. The reason for
this is that the issuer can simply issue new debt at a lower rate of interest, effectively reducing
the overall cost of their borrowing, instead of continuing to pay the higher effective rate on the
borrowings.

Definition of 'Put Provision'

A condition that allows a bondholder to resell a bond back to the issuer at a price - which is
generally par - on certain stipulated dates prior to maturity. The put provision is an added
degree of security for the bondholder, since it establishes a floor price for the bond. This
mitigates the risk of a decline in the bond price in the event of adverse developments such as
rising interest rates or a deterioration in the credit quality of the bond issuer.

Investopedia explains 'Put Provision'

Since a put provision gives the bondholder the right but not the obligation to sell or "put" the
bond to the issuer, it is akin to the sale of a put option by the bond issuer to the bondholder. As
a result, a bond with a put provision will generally be priced higher than a comparable bond
without a put provision.

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