Accrued interest is the amount of interest that has been earned by the seller of a bond but is paid to the buyer (as the holder of record date for the next coupon payment). It is the interest earned between the previous coupon payment date and the date of the transaction. There are a number of different conventions depending on market practice as to how the accrued interest is calculated. What is important is that at the transaction date both parties know exactly what portion of the coupon belongs to each party.
Full price is when the price of the bond traded includes the accrued interest. It is a convention in the United States that bonds trade at full price, or dirty price. Clean price is when the price excludes the accrued interest.
Early retirement provisions
The issuer may be given the flexibility (a right not an obligation) to retire bonds prior to the stated maturity date. Remember that this is an option that modifies the cash flows of a bond and hence may affect the expected return.
This early retirement would be achieved with:
The price that the issuer must pay to retire the bond using this call option is called the call price. The call price is in most cases higher than par and there is typically a call schedule, i.e. different call prices on different call dates. The higher call price is intended to compensate the investors for the loss of maturity.
Issuers are restricted on the earliest date they can exercise the call option. It is typically a number of years after the issue date, because the investor must be given the assurance that the bond is initially intended as a medium- or long-term instrument, otherwise investors might as well invest in short-term money market instruments. This feature of an issue is called a deferred call. The first call date is the date when the bond may first be called. The implication of call provisions is that there will be different computed yields for different call dates.
An issuer can call the bond in its entirety or simply in part. When it is called in part, there are two ways that an issuer can select which certificates are to be redeemed, i.e. on a random or on a pro rata basis. The pro-rata basis is rare for a public issue due to administrative difficulties. The random selection requires transparency of the process such as publication of the actual serial numbers and how they were selected.
Watch for non-refundable and non-callable provisions. Non-callable means there is absolute protection that an issuer is not permitted to redeem the bond prior to maturity. Non refundable means that the issuer can only call the bond as long as it is not for refunding purposes, for example to reduce their debt level.
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