What is Accrual Bond?
Understanding Accrual Bond
An accrual bond's interest is added to the principal balance of the bond and is either paid at maturity or, at some later date, when the bond starts to pay both principal and interest in light of the accrued principal and interest to that point.
A traditional bond includes making periodic interest payments to bondholders as coupons. The interest is paid at scheduled dates until the bond terminates, at which point, the principal investment is repaid to the bondholders. Be that as it may, not all bonds make scheduled coupon payments. One such bond is the accrual bond.
An accrual bond concedes interest, for the most part until the bond develops. This means interest is added to the principal and subsequent interest computations are on the developing principal. As such, the interest due on the accrual bond in every period [accretes](/growth of-discount) and is added to the existing principal balance of the bond due for payment sometime in the future.
An accrual bond is commonly issued with a long-term maturity (20 to 25 years) by corporate substances and is sold at a deep discount, which addresses the interest earned on the bond, to it's face value. In spite of the fact that interest isn't paid all through the bond's life, the Internal Revenue Service (IRS) actually requires holders of accrual bonds to report the imputed interest on the bond as interest income for tax purposes.
The interest doesn't be guaranteed to must be paid at maturity. It could likewise be paid sooner or later after the interest has accrued up to a certain level. At the point when the bond starts to pay both principal and interest in view of the accrued principal and interest by then, this is known as a Z tranche and is common in collateralized mortgage obligations (CMOs).
In a CMO that incorporates a Z tranche, the interest payments that generally would be paid to the Z-tranche holder are utilized to pay down the principal of another tranche. After that tranche is paid off, the Z tranche starts to pay down in view of the original principal of the tranche plus the accrued interest.
As opposed to a zero-coupon bond, an accrual bond has an obviously stated coupon rate. Like a zero-coupon bond, an accrual bond, or Z tranche, has limited to no reinvestment risk. This is on the grounds that the interest payment made to bondholders is delayed. In any case, accrual bonds, by definition, have a longer duration than bonds with the very maturity that make customary interest or principal and interest payments. Accordingly, accrual bonds are subject to greater interest rate risk than bonds that make periodic payments over their whole terms.
- Accrual bond interest is added to the principal and subsequent interest computations are on the developing principal.
- An accrual bond concedes periodic interest payments ordinarily until maturity, similar as a zero coupon bond, with the exception of the coupon rate is fixed to the principal value.
- Accrual bonds are sold at a deep discount, have limited to zero reinvestment risk, and are subject to greater interest rate risk than normal bonds.