Explanation

Correct Answer: B

Accrued interest is indeed equal to a bond's full price (also called dirty price) minus its flat price (also called clean price). This relationship is fundamental in bond pricing:

Full Price (Dirty Price) = Flat Price (Clean Price) + Accrued Interest

Therefore: Accrued Interest = Full Price - Flat Price

Why the other options are incorrect:

A. depends on a bond's yield-to-maturity. - Incorrect. Accrued interest does NOT depend on yield-to-maturity. Accrued interest is calculated based on:

• The coupon rate
• The number of days since the last coupon payment
• The day count convention (e.g., 30/360, actual/actual)
• The coupon frequency

Yield-to-maturity affects the bond's price, but not the accrued interest calculation.

C. is typically included in the price quoted by bond dealers. - Incorrect. Bond dealers typically quote the flat price (clean price), not the full price (dirty price). The accrued interest is added separately when settling the transaction. This is standard practice in bond markets because:

1. It makes price comparisons easier (accrued interest changes daily)
2. It separates the interest component from the principal value
3. It allows for clearer analysis of price movements

Key Concepts:

• Flat Price (Clean Price): The quoted price of a bond, excluding accrued interest
• Full Price (Dirty Price): The actual amount paid by the buyer, including accrued interest
• Accrued Interest: Interest earned but not yet paid since the last coupon payment

Calculation Example: If a bond has a flat price of $980 and accrued interest of $15, the full price would be $995. The buyer pays $995, receives the next coupon payment, and effectively earns interest for the period they held the bond.