Accounting for P&L When Bonds Mature
Summary
The document discusses how to account for a position that disappears from a portfolio at maturity, using a bond as an example. On the maturity date, accounting derecognizes the bond and records the expected cash payment. Operational settlement may arrive later, so the accounting entry can precede actual access to the funds.
If payment is expected and the bond's observable dirty price is close to its cash flow, removing the asset and recognizing the payment should produce little net P&L. If credit concerns leave the bond trading below face value despite no official default, derecognizing it at fair value and recording the expected payment can create a gain. If payment then fails, that receivable must be reversed and the defaulted bond recognized. The discussion highlights that maturity-day P&L depends on the market value and certainty of the cash flow, not simply on assigning the change to theta. It offers a conceptual accounting example, not a universal operational or accounting rule.
Key ideas
- A maturing bond may be removed from accounting records before its cash payment is operationally received.
- When the bond's fair value matches the expected payment, maturity recognition should create little net P&L.
- A credit-risk discount at maturity can produce a gain when the expected cash flow is recognized.
- If the payment fails, the receivable is reversed and the defaulted bond is recognized.
- Maturity P&L treatment depends on fair value and payment uncertainty.
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# P&L Decomposition Expired Trades # P&L Decomposition Expired Trades If a trade exists yesterday (T-1) and not today (T) owing to maturity at T, how do you account for the change in P&L between T-1 and T? I think it should be under Theta but are there any cases where you would want to ignore this P&L for a trade maturing today altogether? ## Answer by Dimitri Vulis (score 0, accepted) https://quant.stackexchange.com/a/80695 This is actually tricky sometimes. I don't have a perfect answer. In my opinion, accounting practices don't quite describe what happens operationally. As an example, never mind derivatives, suppose you own a bond that matures on day $T$. If it hasn't defaulted, then accountants say, derecognize the bond asset, pretend that you received a cash flow on day $T$, and are immediately free to spend it. In reality, you may get the cash flow a few days later, and might run into problems if you try to spend it before you operationally receive it. Almost always, at time $T$, you know whether you will get the cash flow. If the bond issuer hasn't signaled that they're defaulting, then the observable dirty price of the maturing bond will equal the cash flow, so the fair value of the bond asset that you de-recognize will be offset by the cash flow that you recognize (although, as I said, it may come some days after you recognize it), so the net P&L should be close to 0. If, even on maturity day $T$ there hasn't been an official default, but there are doubts about the cash flow happening, so the bond is trading below face value, then you still de-recognize the bond at its observable fair value - below its face value - and recognize the cash flow, so the net P&L is positive, and if the cash flow comes, it does so as a pleasant surprise. And if the cash flow doesn't come, then you de-recognize the cash flow and re-recognize the defaulted bond. You may sometimes see the not yet defaulted, and supposedly matured, credit-risky bond trading below its face value in the secondary market. See Evergrande for an example of default after $T$.
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