What is the difference between clean price and dirty price of a bond?
Clean price and dirty price are terms used in bond valuation. The clean price refers to the price of a bond excluding accrued interest, while the dirty price includes accrued interest. When a bond is traded between coupon payments, the buyer compensates the seller for the accrued interest since the last coupon payment. For example, consider a 10-year bond with a face value of Rs. 1,000, a coupon rate of 5%, and a duration of 5 years.
If the bond is traded 6 months after the last coupon payment, the dirty price would include the accrued interest for those 6 months. Understanding the difference between clean and dirty prices is essential for investors to accurately assess the true cost of purchasing a bond.