Bond interest does not belong entirely to the person who receives the next coupon payment. It belongs to whoever held the bond while that interest was being earned. Accrued interest exists to make that distinction fair.

It ensures that interest income is allocated based on time held, not on coupon payment dates.

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What Accrued Interest Really Is

Accrued interest is the interest that has accumulated on a bond since the last coupon payment date.

It reflects interest that has been earned but not yet paid. Even though the cash has not been received, the value has already been created.

This concept becomes relevant whenever a bond is traded between coupon dates.

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Why Accrued Interest Matters in Bond Trading

When a bond is sold between coupon dates, the buyer will receive the full next coupon.

However, part of that coupon was earned while the seller still owned the bond. Accrued interest ensures the seller is compensated for that earned portion.

As a result:

• the buyer pays accrued interest to the seller
• the seller is made whole for the holding period

This adjustment prevents double counting or unfair allocation.

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Clean Price vs Dirty Price

This distinction is frequently tested.

• Clean price excludes accrued interest
• Dirty price includes accrued interest

The actual amount paid in a bond transaction is the dirty price. Quoted bond prices in markets are usually clean prices for ease of comparison.

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Accrued Interest and Accounting Recognition

From an accounting perspective, accrued interest represents income that has been earned but not yet received.

It appears in financial statements as interest receivable for the holder. This timing recognition aligns income with the period in which it is earned, not when cash is received.

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Day Count Conventions

The amount of accrued interest depends on how days are counted.

Different bonds use different conventions to determine how much interest accrues per day. Exams often test whether candidates understand that accrued interest depends on both time and convention, not just the coupon rate.

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Common Student Misunderstandings

Many students think accrued interest is an extra cost. It is not.

Others believe accrued interest benefits the issuer. It does not.

Some forget that accrued interest is paid by the buyer but later recovered through the full coupon payment.

These misunderstandings frequently appear in exam traps.

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Closing Reflection

Accrued interest exists to match income with ownership over time. It ensures fairness between buyers and sellers and keeps bond pricing consistent across trading dates. For CFA and FRM preparation, the key is understanding why accrued interest is paid, who pays it, and how it affects transaction prices. Once that logic is clear, bond pricing questions become much easier to interpret.