Compound Accreted Value (CAV)

What Is Compound Accreted Value (CAV)?

Compound accreted value (CAV) is a measure of the value of a zero-coupon bond at a point in time prior to its maturity date. The CAV is calculated by taking its original purchase price and adding the accrued interest recently earned by the bondholder.

CAV is a helpful measurement for bond investors. As well as implying the current value of the bond, CAV can likewise be helpful for determining whether the bond issuer is probably going to call the bond. On the off chance that the bond is called, this would force the bondholder to sell the bond back to the issuer, getting a cash payment equivalent to the bond's CAV.

How CAV Works

CAV is widely utilized among buyers and sellers of zero-coupon bonds. These unique investment vehicles don't pay interest during their term, however rather accrue interest that is paid out at the bond's maturity date. Put in an unexpected way, zero-coupon bonds give a return to investors by permitting them to purchase the bond at a substantial discount to its face value.

At times, the issuer might give a schedule of compound accreted values to investors in an official statement. This document, prepared regarding a primary offering, incorporates pertinent data, for example, how the securities will be repaid and the financial qualities of the issuer. This can assist investors with rapidly grasping the projected value of the bond throughout its term, as well as the creditworthiness of the borrower.

Working out a zero-coupon bond's CAV turns out to be particularly important on the off chance that the bond conveys a call provision. The call provision permits the issuer to buy back, or retire, the bond. This is on the grounds that call provisions for zero-coupon bonds are typically linked to the bond's CAV. The provision will for the most part specify that the issuer can call the bond on a specific date at a price that is a premium to the bond's CAV. A zero-coupon bond is trading at a premium in the event that it costs more than its CAV at that specific point in time. On the other hand, the zero-coupon bond is trading at a discount on the off chance that it costs not exactly its CAV.

True Example of CAV

To illustrate, consider the case of a 10-year zero-coupon bond with a interest rate of 10% each year. Since it is a zero-coupon bond, this instrument wouldn't really pay out its interest every year. All things being equal, the investor would basically receive a large buyout toward the finish of year 10 mirroring the accumulated interest that was earned (or "accrued") over the course of that time. Accepting an original purchase price of $1,000, for example, this 10-year bond would pay out $2,593.74 toward the finish of its term. As such, the bond's CAV toward the finish of year 10 would be $2,593.74.

To sell their bond before the finish of the term, then the bond would be valued at its CAV, which is equivalent to the purchase price of the bond plus any accrued interest that has been earned up to that point in time. In the event that, for example, the investor sells the bond toward the finish of year 5, then, at that point, its CAV would be $1,610.51. Similarly, the CAV would be lower assuming the bond were sold before, and it would be larger on the off chance that it were sold later in the term.

Features

• It is frequently used to work out the value of such bonds prior to their maturity date.
• Compound accreted value (CAV) is a measure of the value of a zero-coupon bond.
• Bond issuers once in a while furnish investors with a schedule of projected CAVs throughout the bond's term. This data can be valuable to guess whether the bond is probably going to be called by the issuer.