Dirty Price Versus Clean Price: Bond Market Jargon And Conventions
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- Опубликовано: 6 янв 2018
- InsidersGuideToFinance.com
insidersguidetofinance
This presentation addresses a common misstatement encountered in most introductions to fixed income securities and markets. A bond’s price is usually defined as the present value of its future coupon and principal payments. That is usually not true, at least given the way most market participants would interpret price. The video explains market conventions and jargon regarding a bond’s clean price versus its dirty price
Really good content, thank you!
If there is no distinction between dirty price and PV of cash flows, why does anyone bother with the clean (so-called market) price? If that is not the number at which people trade, why do we call it the market price?
Bonds can be quoted by either dirty or clean price, though clean (i.e., flat or market price) is much more common. (Not sure if it is still true, but bonds used to be quoted by the dirty--or full--price in Chile.) And both prices are readily available to anyone using a trading screen (whether on a home computer or a Bloomberg machine on a trading desk).
The primary reason for quoting by flat price is that it makes bond prices more comparable. The flat price reflects the value of the cash flows from the trade settlement date to maturity (i.e. the net contract cash flow the buyer is purchasing (assuming no default and the bond being held to maturity). The accrued interest that is added to the market price when paying for a purchase is just a recognition of the interest the bond had earned from the last coupon date up to the settlement date of the trade (i.e. interest that has really been earned by the seller).
When bonds are quoted by dirty prices, securities with different coupon dates are not directly comparable (e.g. one bond might have last paid a coupon 1 month ago, another bond may have paid a coupon 5 months previously). In neither case is the buyer earning the 1 or 5 months of interest. When the accrued interest is added to the amount of money due at settlement, the buyers are compensating the sellers for interest already earned (which the buyers recoup when they collect the full coupon on the next coupon payment date). To make these 2 bond's dirty prices comparable (i.e. their values reflecting only the cash earned by the buyer from trade settlement onward), the accrued interest would have to be subtracted from the dirty price (i.e. converted into the market price). That is really all the buyers are buying.
@@insidersguidetofinance1388 Thank you. So can we say that the importance of the clean price is just to compare bonds i.e. if you have more than one choice but actually the price paid is the dirty (full) price.
@@ihabtaher9648 Hello Ihab, You have very nicely summarized the issue. I am very glad you found the video interesting.
Unfortunately, even with a bon'd's clean price making accurate comparisons between different securities is still difficult because bonds being compared will usually not be identical due to various differences (e.g., coupon rates, maturities, credit risk). That is why fixed income professionals compare bonds on the basis of their yields to maturity.
If that is a topic of interest to you I have a yield to maturity playlist that includes 4 videos on the subject you may find informative. If you find some of my videos useful please share them with friends/colleagues;). Cheers,' Doug
@@insidersguidetofinance1388 Thank you so much.
hmmm