Definition
The term “Clean Price” in finance refers to the price of a bond excluding any interest accrued. It is the price only of the bond itself without taking into consideration any interest payments due. Thus, it reflects the amount that would be paid for the bond alone, not including any outstanding interest.
Key Takeaways
- The clean price is the amount that would be paid for a bond or security excluding any interest or dividends that have accrued. It is the actual price of the bond itself.
- Clean prices are usually quoted in newspapers and are used in most financial and economic analyses as they represent the value of the bond separate from its income components.
- When buying a bond, investors will pay the clean price plus the accrued interest (dirty price), but it is the clean price that reflects the real value of the bond.
Importance
The finance term “Clean Price” is important because it represents the actual price or cost of a bond without the accrued interest.
While trading bonds, both sellers and buyers need to consider not only the selling price but also the interest that accumulates between coupon payments.
The clean price helps to provide a clear and precise understanding of the bond’s price, separate from its accrued interest, facilitating a more transparent and honest trading process.
This clear distinction further aids in more accurate financial planning, investment decisions, and risk assessment and allows investors to compare the costs of different bonds more readily.
Explanation
The clean price of a bond primarily serves to provide a straightforward, uncomplicated measure of a bond’s price without factoring in any accrued interest. This standard benchmark helps in the fair and consistent pricing of bonds.
In the daunting world of bond trading, many factors can influence the cost of a bond including its time to maturity, perceived risk, and the cumulative interest. Hence, the clean price is used as a baseline that provides a simple and understandable point of reference.
Moreover, the clean price offers a reliable way of comparing bonds from various issuers or even across different markets. These comparisons could be distorted if the prices were to include accrued interest, especially since bonds from different issuers or markets could have varying coupon payment dates and structures.
Thus, the use of clean price simplifies comparisons and significantly reduces complexity when evaluating investment options, thereby aiding investors in making informed decisions.
Examples of Clean Price
Example 1: Purchasing a Bond at Face ValueLet’s consider a bond that a company issues with a face value of $1,
In this case, the bond’s clean price is $1,000, which is what the investor would pay to purchase the bond, not including any accrued interest. If the bond pays interest semi-annually and you buy it six months after the last payment, you would owe the seller the accrued interest for those six months. However, the clean price remains $1,000 – the face value of the bond. Example 2: Selling a Bond Before Maturity DateImagine that you purchased a bond for $5,000 five years ago and decided to sell it today, a few years before its maturity date. The clean price of the bond would be the market price it is sold for today, not considering any interest that has accrued since the last coupon payment. Let’s say, this clean price at the time of selling is $4,
Example 3: Buying an Existing Bond from Another InvestorSuppose you are an investor interested in buying a ten-year bond in its fifth year from another investor. The seller purchased the bond at its face value of $10,
At the time of selling, the market price of the bond is $9,
Here, the clean price for you would be $9,500, not including any accrued interest from the last coupon payment to the time of buying.
FAQs: Clean Price
What is Clean Price?
Clean Price is the price of a bond without considering the accrued interest since the last coupon date. It reflects only the intrinsic value of the bond itself.
Why is Clean Price important?
Clean Price is important because it’s the price actually quoted in most trading markets and mitigates the effect of interest that would have collected since the last payment. This makes comparison between different bonds easier for investors.
How is Clean Price different from Dirty Price?
While Clean Price excludes accrued interest, the Dirty Price includes the accrued interest. In other words, if you buy a bond at its Dirty Price, you pay the Clean Price plus accrued interest.
How is Clean Price calculated?
Clean Price is calculated by deducting the accrued interest from the Dirty Price.
Does Clean Price fluctuate?
Yes, the Clean Price of a bond can fluctuate based on market conditions, specifically changes in interest rates. If interest rates rise, the clean price generally falls, and vice versa.
Related Entrepreneurship Terms
- Dirty Price
- Accrued Interest
- Bond Pricing
- Yield to Maturity
- Face Value
Sources for More Information
Sure, here are four reliable sources where you can find more information about the finance term “Clean Price”:
