Clean price and dirty price are terms associated with the bond market. When bond prices are quoted exclusive of interest accrued (ex-interest), the same is termed as 'clean price'. On the other hand, price including the accrued interest (cum-interest) is called Dirty Price.
Therefore, Dirty Price = Clean Price + Accrued Interest.
The concept of clean and dirty price explained
Take note of the following features associated with the bond markets:
- Bonds carry a fixed rate of interest.
- Interest payments are made at fixed intervals (Monthly, Quarterly, Semi-annually, Annually etc.)
- When an investor acquires a bond, he/she will be eligible to receive dividends on the next interest payment date. This is irrespective of the fact that he/she might not have held the bond for the entire tenure for which the interest is being paid. It is for this reason that the buyer has to pay to the seller, on the date of purchase, the interest accrued from the date of last interest payment till the date of purchase.
Example: 8% GOI 20xx is quoted at a clean price of Rs 110
Face Value = Rs. 100
Interest Payment Date = 31st Dec (Annually)
Date of purchase: 1st October
Accrued interest = (Rate of interest) x (No. of days since last Int. payment date/360) x (Face Value)
No of days since the last interest payment date: 270 days
Accrued Interest: (0.08) x (270/360) x 100 = Rs. 6
Dirty Price = Clean Price + Accrued Interest = 110 + 6 = 116