Fixed IncomeClass NotesChapter 4 – 10/27/11Accrued interest is interest earned but not yet paid. As time goes on, a bond will accrue interest payable to the bondholder. As interest payments are made, for example by a coupon’s redemption, accrued interest is reduced by the amount paid. Immediately before a coupon date, accrued interest equals the full coupon payment and the present value of the nextcoupon payment equals that same payment. Discount factors summarize market prices for money on future dates while interest rates simply quote those prices derived from whatever convention is deemed most convenient for the application on hand. When cash flows (interest or principal repayments) occur in other than six month increments, semi-annual compounding is very awkward Monthly or daily comp8nding of interest that allows redemption of interest at any time is called continuouscompounding. When cash flows arrive at different times, the continuous compounding convention is most convenient.
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