Accretion
Candlefocus EditorAccretion is an essential concept in the investment and finance world, as it is the key factor that determines the returns an investor can expect from purchasing bonds at a discount. It is important because the accretion rate can only be calculated before the purchase of the bond and thus it provides the investor with all the information and the potential returns they can expect to reap.
The accretion rate of a bond is determined by dividing the bond’s discount amount, which is the difference between the original price and the face value, by the number of years left until the bond matures. This rate is also influenced by the coupon rate of the bond, which is the payment the bondholder receives from the issuer of the bond.
For example, if a bond discounted at $800 has a face value of $1000 and a 10-year maturity period, the accretion rate would be 0.08%. On top of this, if the coupon rate of the bond is 8%, the investor will also receive 8% in payments every year until the bond reaches maturity, thus increasing their returns.
Accretion is typically associated with bonds that are issued at a discount, such as zero-coupon bonds and Treasury STRIPS. These investments carry greater risk and are subject to market volatility, making it important to understand the concept of accretion before investing in them.
Accretion is a useful concept to understand when investing in bonds, as it determines the amount of income an investor expects to receive after purchasing the bond and holding it until maturity. Knowing the accretion rate, investors can calculate whether the bond is worth investing in and how much income they stand to gain.