ACCRUED INTEREST

Applies mainly to convertible securities. Interest that has accumulated between the most recent payment and the sale of a bond or other fixed-income security. At the time of sale, the buyer pays the seller the bond's  price plus "accrued interest," calculated by multiplying the coupon rate by the fraction of the coupon period that has elapsed since the last payment. (If a bondholder receives $40 in coupon payments per bond semiannually and sells the bond one-quarter of the way into the coupon period, the buyer pays the seller $10 as the latter's proportion of interest earned.)

Interest which has been earned, but which has not yet been paid. When bonds are traded (bought or sold), they trade ‘with accrued interest’, meaning that the portion of interest which will be paid on the next coupon date which was earned by the seller, is paid by the buyer. Interest is calculated from either the dated date, first coupon date or the most recent coupon date—whichever is later. The buyer then keeps the entire amount of the coupon payment.

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Interest earned but not yet paid. For most taxpayers, tax is due in year accrued interest is paid. When buying a bond, buyer pays seller any interest accrued since the last payment date. When the buyer eventually sells the bond, the new buyer pays any accrued interest. The accrued interest is subject to taxes for the seller, but reduces the tax liability for the buyer. For example, if a bond buyer paid $30 accrued interest to a seller, then received $150 interest for the rest of the year, the buyer needs to pay taxes on $150 - $30 = $120.

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See also Coupon, Dated Date, First Coupon and Interest Rate.