Dirty Price - Bond Pricing

Bond Pricing

Bonds, as well as a variety of other fixed income securities, provide for coupon payments to be made to bond holders on a fixed schedule. The dirty price of a bond will decrease on the days coupons are paid, resulting in a saw-tooth pattern for the bond value. This is because there will be one fewer future cash flow (i.e., the coupon payment just received) at that point.

To separate out the effect of the coupon payments, the accrued interest between coupon dates is subtracted from the value determined by the dirty price to arrive at the clean price. The accrued interest is based on the day count convention, coupon rate, and number of days from the preceding coupon payment date.

The clean price more closely reflects changes in value due to issuer risk and changes in the structure of interest rates. Its graph is smoother than that of the dirty price. Use of the clean price also serves to differentiate interest income (based on the coupon rate) from trading profit and loss.

It is market practice in US to quote bonds on a clean-price basis. When a bond settles the accrued interest is added to the value based on the clean price to reflect the full market value.