A great and popular saying in the bond market says that ‘Buy Clean, Pay Dirty‘ which means,buy at a clean rate while sell with accrued interest.
In simple words clean price is nothing but the bond price without interest, while the dirty price is the bond with addition of accrued interest for that particular tenure.
Clean price is the price which the seller of the bond has paid earlier. It is the price usually quoted. It is the net of the accrued interest.
While the dirty price is the price which the buyer of the bond has to pay to the seller at maturity. Dirty price includes clean price.
Clean price is also known as flat price. Dirty price is also known as full price.
Dirty price= clean price+accrued interest. While Clean price= dirty price- accrued interest. Accrued interest= coupon payment* days since last coupon payment/days in coupon period.
Let’s see the concept with few numbers:
$1000 Face value , 6% coupon , 3 years annual payment bond issued on 1 January 2021 ( total interest for 12 months = $60 ) . If the Bond holder sells this bond to other investor on 30 April 2021 , bond trading on 30 April, 2021 at $1005 . Seller held the bond for 4 months so intrest due is $20 on 30 April, 2021 . CLEAN PRICE = $1005 DIRTY PRICE = Clean price + accrued interest ( $1005 + $20 = $1025 )
One should must have clarity between these two while trading bonds. So that one can Buy clean and Pay dirty.
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