What is the dirty price?
A dirty price is a bond price quote, which refers to the cost of a bond which includes accrued interest based on the coupon rate. Bond price quotes between coupon payment dates reflect interest accrued up to the day of listing. In short, a dirty bond price includes accrued interest, while a net price does not.
Key points to remember
- A dirty price is a bond price quote, which refers to the cost of a bond which includes accrued interest based on the coupon rate.
- If a bond quotes between the coupon payment dates, the quoted price includes the interest accrued until the day of listing.
- In short, a dirty bond price includes accrued interest, unlike a clean bond price.
- Clear quotes are typical in the United States, and dirty quotes are standard in Europe.
Understanding the dirty price
Accrued interest is earned when a coupon bond is currently between the coupon payment dates. As the next coupon payment date approaches, accrued interest increases daily until the coupon is paid. On the day of payment of the coupon, the net price and the dirty price are equal since there is no accrued interest until the next market day.
The dirty price is sometimes called the gross price. In the United States, the net price is more often cited while in Europe, the dirty price is the norm.
The dirty price allows a seller to calculate the real cost of a bond, since it may have generated interest from the date of payment of the previous coupon. Thus, the date of the sale would reflect the net price plus accrued interest, calculated daily. Therefore, the actual price paid by the buyer for the bond is higher than the price listed on financial websites, as it takes into account accrued interest and the broker’s commission.
Interest increases at a constant rate on a bond and the amount earned is calculated daily. Consequently, the dirty price will change daily until the date of payment or payment of the coupon. Once the payment is completed and the accrued interest reset, the dirty and clean prices are the same.
In the case of bonds offering semi-annual payments, the dirty price would increase slightly every day in six months. Once the six-month deadline has been reached and the coupon has been paid, the accrued interest is reset to restart the cycle. The dirty process to be cleaned continues until the link matures.
Dirty Vs. Own prices
The dirty price is generally quoted between brokers and investors, but the net price or the price without accrued interest is generally considered to be the published price. The net price would likely be recorded in newspapers or financial resources that track prices. Although the dirty price includes accrued interest, the net price is often considered the value of the bond in the current market.
Real example of a dirty price
For example, let’s say that Apple Inc. (AAPL) issued a bond with a face value of $ 1,000 while $ 960 is the published price. The bond pays an interest rate – coupon – of 4% per year, and these payments are semi-annual. As a result, investors would receive $ 20 every six months for holding the bond.
The price of $ 960 is the published price or the net price. However, an investor seeking to purchase the bond would receive a quote from a broker that includes the $ 960 plus accrued interest. The broker would calculate the daily accrued daily allowance. Suppose there is no brokerage commission. Depending on the day the investor made the purchase, the accrued interest varies.
Thus, if the investor purchased the bond one day before the first coupon payment of $ 20, this translates into $ 19 of accrued interest up to that date. The price of the investor’s bond would be $ 979, or $ 960 plus $ 19 of accrued interest.