In finance and business the term accrued interest refers to the interest that has been built-up since the principal investment of a bond or loan.
The interest for financial instruments such as bonds is constructed and paid in predetermined installments (usually annually or quarterly).
A bond or loan can be transferred at any point in time and not just when coupons are paid. In the world of bonds, the term coupon refers to the interest payments, usually done twice a year.
The current owner of the financial instrument is the one who receives the coupon payment, while the previous owner who sold the financial instrument is only compensated for the period that they held it.
Bonds are commonly sold on dates other than when coupons (interest) are paid.
Essentially this means that the previous owner of the financial instrument is paid the interest that was accrued before the sale.
How to calculate accrued interest:
According to the Municipal Securities Rulemaking Board, the formula for calculating accrued interest on a 360-day year is:
Accrued Interest = (Interest Rate)*(Par Value)*(Number of Days / 360)
The formula for calculating the interest accrued in a set period is:
IA = T x P x R
Where IA Is the accrued interest, T is the fraction of the year, P is the principal, and R equals the annualized interest rate.
To calculate T the following formula is typically used:
T = DP/DY
DP = The number of days in the set period.
DY = The number of days in the year.
Examples of accrued interest:
Assume that on July 21 a city sold a $5,000,000 new issue of municipal bonds. The bonds were dated May 1 and settled on November 15. The interest rate on the bonds was 3.5 percent.
Accrued interest paid on settlement date = (.035) * ($5,000,000) * (198/360) = $96,250
To find out how much interest is owed on a given bond or loan, you can use the Accrued Interest Calculator, brought by the Financial Industry Regulatory Authority, Inc.