Bond Yield to Maturity Uses Dirty Price for Typical Clean-Quoted Bonds

Summary

Yield to maturity is the internal rate of return on the bond’s purchase outlay and its future coupon and principal payments. For bonds quoted clean, the cash paid at settlement includes both the quoted price and accrued interest, so the yield calculation should use that dirty price. Accrued interest compensates the seller for the portion of the current coupon period that has elapsed; it is separate from the future coupon cash flow, which remains payable in full.

The explanation distinguishes common market practice from exceptions. Distressed bonds that have not yet defaulted are often quoted dirty, so accrued interest should not be added again. Preferred shares, which resemble perpetual bonds, and some bonds in emerging markets may also be quoted dirty. The guidance is about matching the yield calculation to the instrument’s quotation convention; it does not provide a complete pricing formula or address the detailed conventions for particular markets.

Key ideas

• Yield to maturity measures return on the buyer’s settlement outlay and future cash flows.
• For a clean-quoted bond, add accrued interest to the quoted price when calculating proceeds.
• The bond’s next coupon remains a full payment even when part of its accrual period has elapsed.
• Some distressed securities, preferred shares, and emerging-market bonds may be quoted dirty, requiring different treatment.

Tags

# YTM and Accrual


# YTM and Accrual












Can you please clarify if the YTM (yield to maturity) of a bond is the implied yield using the clean price or the dirty price? Does YTM incorporates interest accrual ? If so, let's assume my bond pays semi annual coupons and the currently accrual period is 3 months

for example semi annual coupon = $3 that will be paid in 3 months, which one should I use:

dirty price = $3/(1+YTM)^1/4 + ...

or

clean price = $1.5/(1+YTM)^1/4 + ...

## Answer by Dimitri Vulis (score 2, accepted)

https://quant.stackexchange.com/a/80743

A yield is the internal rate of return of a series of cash flows: you pay "proceeds" to buy the the bond and subsequently receive coupons and principal repayments.

Coupon-paying bonds have positive accrued on most settlement dates, except at the start of a coupon period.

Most bonds in most markets are quoted "clean", meaning that to calculate the proceeds, you indeed need to add to the quoted price the amount accrued until the settlement date.

Calculating a yield using only a clean price, excluding the accrued, would be less meaningful.

But there are a few exceptions that you should keep in mind:

Bonds that are distressed, but not yet defaulted, are usually quoted dirty. Don't add the accrued. (And don't calculate yields of defaulted bonds.)

Preferred equities are a lot like perpetual bonds, but are quoted dirty.

In a few emerging markets, such as Brazil, bonds that are not distressed are also quoted dirty. Etc.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.