As described by its name, clean price is the financial term for the actual price of a bond excluding all the collected interest since the issue of the bond or its last coupon payment.
Bonds Clean price never includes the accrued (collected) interest between any coupon payments for the bond.
In addition to this, the coupon and interest prices are paid usually on a semiannual basis but the issuer has all rights to modify it to yearly, quarterly or even on a monthly basis.
The opposite of clean price is the dirty price which includes all the accrued interest based on its coupon rate of the bond. Some countries quote prices using dirty price while some quote using a clean price.
Usually while quoting bond prices on Reuters or Bloomberg terminal, clean price of the bond is used more often.
If we talk about countries, security markets in the United States (U.S.) are more likely to rely on clean price while quoting bond prices as compared to the markets in Europe where the dirty price is preferrable.
There is a major difference between clean and dirty price. For instance, when there is a change in clean price, more often than not it is due to an economic reason including a change in the issuer’s quality or credit or interest rate.
This makes clean price a more stable option as compared to dirty price because the change in dirty price more likely depends on the current date in relation to the coupon rates, apart from the economic reasons.
If we talk about clean price, the accrued interest is added back to the value of the quoted price in order to determine the settlement price which is to be paid by the investor. Clean price is also referred to as flat price.
Calculation of Clean price
The calculation of this amount can happen on a daily basis since interest accrues more steadily on a bond. As a consequence, the dirty price will be changing daily until the coupon payment is made on the final date.
After the payout of the coupon rate is complete the amount of accrued interest is again reset to nil. This is the point where both, dirty and clean prices are the same, i.e. zero.
Bonds are quoted as either a percentage of their par value, or face value, or in dollar terms. For example, if a bond is quoted at 96, this indicates that it is 96% of the bond’s par value.
Ergo, if par value of the bond is $1,000, the bond price will be $960. The $960 price quote will be categorized as the clean price of the bond since there is no involvement of accrued interest in its price.
Investors pay the dirty price unless the bond is purchased on the coupon payment date but usually bonds are typically quoted in terms of the clean price.
As far as the formula for calculating the clean price is concerned, the values of dirty price and accrued interest can help in the same.
Use the formulae for calculating Clean Price or Dirty Price
Clean Price Example
For instance, XYZ Ltd. issued a bond with a face value of $500 whereas $480 is its published price. The bond is defined to pay 4% interest/coupon rate on a semiannual basis.
Ergo, the investors are bound to receive $20 every 6 months till the maturity date.
In this case, $480 will be referred to as the clean price. The bond price to be quoted to investors will be $480 plus the accrued interest (if any). The broker calculates the daily smidgen of interest that is accumulated and it is added to the amount of the clean price.
The dirty price would be unsteady as it depends on how many days since the last coupon payment. Interest is accumulated immediately following the last payment of coupon.
Now there can be two different scenarios:
- We suppose the investor bought the bond one day before the payment of the first coupon, i.e. $20. In this case, there will be an accrued interest which will be calculated at approximately $19.90 (up to that date). This is why the bond price quoted for the investor would increase by the amount of accrued interest, i.e. $480 plus $19.90 or 499.90. This is a demonstration of a dirty price.
- In the case where the investor buys the bond on the date of coupon payment, no accrued interest will be calculated. So the price to be quoted for the bond will be nothing more than $480. This demonstrates a clean price.
Finally, after the payment of coupon price, both dirty and clean prices become equal when the accrued interest is removed from the quoted bond price. In this example, it happens on a semiannual basis.
Clean price, as mostly displayed by financial sites is important in such securities’ trading. This formulation is usually practiced in most countries and corporate except the states under the U.K. or more precisely, Europe.
The calculation and norms of clean price and the dirty price are highly dependent upon the dates of acquiring the bond and coupon payments.
If there is no accrued payment, there will be no such difference between both. However, the clean price would be a preferred technique for quoting the bond price because of its stability qualities.