Accrued Interest

When you buy a bond between coupon payment dates, the seller has earned interest that hasn’t been paid yet. You compensate the seller for that accrued interest in addition to the bond’s quoted price. This mechanism keeps secondary-market bond trading fair.

Why accrued interest exists

Suppose a Treasury bond pays coupons on January 15 and July 15. You sell it on March 15, three months before the next coupon payment. The next buyer will receive the full July 15 coupon, even though you held the bond for half that interest period. Without accrued interest, you would lose the three months of interest you earned but didn’t collect—an unfair outcome.

Accrued interest solves this. You are paid by the buyer for the interest you earned from the last coupon date to your sale date. The buyer then receives the full next coupon and recoups their accrued-interest payment.

How accrued interest is calculated

Accrued interest is calculated by multiplying the bond’s coupon rate, the principal amount, and the fraction of the coupon period elapsed. A $10,000 bond with a 4% coupon paying semi-annually ($200 per six-month period) sold three months into the period has accrued interest of $100 ($200 × 0.5).

The calculation assumes a 360-day “bond year” and day-count conventions that vary by bond type. Treasuries use actual/actual day counting; corporate bonds typically use 30/360. These details matter for exact calculations but are handled automatically by trading systems.

The invoice price

When you trade a bond, you see a “quoted price” (often called “clean price”) and an “invoice price” (or “dirty price”). The quoted price is what traders discuss—the pure bond price without interest. The invoice price is what you actually pay: quoted price plus accrued interest.

A Treasury bond quoted at 101 (meaning 101% of par) with $50 of accrued interest has an invoice price of 101 + $50/$10,000 = 101.5.

Impact on returns

Accrued interest affects your actual return calculation. If you buy a bond shortly after a coupon date, you pay minimal accrued interest. If you buy just before a coupon date, you pay the seller most of the next coupon in accrued interest. Despite the difference in invoice price, your eventual return should be similar (all else being equal), because you receive less or more of the coupon from the issuer depending on when you bought.

Zero-coupon implications

Zero-coupon bonds and stripped securities don’t have explicit coupon dates, so accrued interest works differently. The bonds accrue value continuously, and the buyer pays the market price for the accrued value. The mechanics are the same—the seller gets compensated for their holding period—but the accounting is implicit in the price rather than explicit in a separate accrued-interest line item.

Tax implications

In the United States, accrued interest is treated as ordinary income, not capital gains. The issuer withholds tax on coupon payments but not on accrued interest. When you sell a bond and receive accrued interest, that amount is taxable as interest income in the year of sale (for most individual investors; tax treatment can differ in retirement accounts).

This is an important consideration for bond traders in taxable accounts, as accrued interest can generate unexpected tax bills.