What Is an Accrual Bond?

Michael Whitman · Trading since 2017, full-time since 2020 · YouTube creator, 137K subscribers · Published 2026-09-14 · Updated 2026-10-19

Take an ordinary bond and remove every payment before maturity. What remains is an accrual bond, and the removal changes its behavior far more than it changes its arithmetic.

How it works

No coupons are paid. Interest accrues and is added to the outstanding principal, so the amount owed grows through the bond’s life.

Everything arrives at the end. One payment, at maturity, comprising the original principal plus all accumulated interest.

Which makes its duration equal to its maturity. A coupon bond’s duration is shorter than its maturity because some money comes back earlier; here, none does.

Why the sensitivity is extreme

Duration is the weighted average time to receiving money. With one payment at the end, that average is the full term — the longest it can possibly be.

And price moves scale with duration. A thirty-year accrual bond can move two or three times as far on the same rate change as a thirty-year coupon bond.

The compensating benefit is certainty. There are no coupons to reinvest, so the return if held to maturity is fixed at purchase regardless of what rates do in between.

A worked example

A twenty-year accrual bond bought at 30 with a face value of 100. No payments occur for twenty years.

The implied return is the rate that grows 30 into 100 over twenty years — roughly 6.2% compounded, and that number is locked at the moment of purchase.

A coupon bond at the same yield is not locked. Its stated yield assumes every coupon is reinvested at that yield, and if rates fall the actual realized return is lower.

Which is a genuine and underappreciated advantage. The accrual bond’s quoted yield is the return you get; the coupon bond’s is a projection resting on an assumption about the future.

Where the structure appears

Government strips. Dealers separate a conventional bond’s coupons from its principal and sell each piece as a standalone zero-coupon instrument, which is the largest and most liquid form of this.

Corporate zero-coupon issues. A company that wants to borrow without servicing cash interest until maturity, which suits a project generating nothing until completion.

Accrual tranches in structured deals. The Z-tranche of a mortgage security accrues while earlier tranches are paid down, absorbing prepayment variability on their behalf.

And that last case is the most dangerous version. A Z-tranche combines maximum rate sensitivity with uncertainty about when the accrual even stops, and it is a structure that has produced losses well beyond what its holders had modeled.

The original data

Compound an annual charge for thirty years and small numbers stop being small: 5 basis points a year removes about 1.5% of the final balance, 20 about 5.8%, 75 about 20.2% and 150 about 36.5%.

That table is compounding measured over exactly the horizon this instrument operates on. An accrual bond is the same arithmetic pointed the other way — a rate compounding in your favor, uninterrupted, for the full term.

And the price sensitivity can be checked by hand. At a 6% yield a twenty-year zero with a face value of 100 prices near 31.18; if the yield rises to 7% it falls to about 25.84, a loss of roughly 17.1%, while a twenty-year 6% coupon bond on the same move loses about 10.6%. A long-dated accrual bond amplifies whatever the rate market does, so an ordinary move in yields produces an unusually large move in price.

The tax problem

In many jurisdictions the accrued interest is taxable as it accrues. Income is assessed each year on an amount the holder has not received and cannot spend.

Which produces a cash-flow mismatch. A tax bill arrives annually against an instrument paying nothing until maturity, and the money to pay it must come from somewhere else.

Tax-sheltered accounts remove the problem entirely, which is why these instruments are held disproportionately inside pensions and similar wrappers.

The general rule is that this is a structure for a specific purpose. Matching a known future liability — a school fee, a defined pension payment — with a known future sum, inside a shelter. Held for any other reason, its properties tend to be liabilities rather than features.

How a strip is created

A dealer buys a conventional government bond and registers its individual payments as separately tradeable securities - each coupon date becomes one instrument and the final principal becomes another.

Each piece is then an accrual bond of its own maturity. A thirty-year bond with semi-annual coupons produces sixty short zeros plus one thirty-year zero, all backed by the same government.

And the process reverses. Reconstitution reassembles the pieces into the original bond, which is what keeps the prices of the parts consistent with the price of the whole - if the sum of the strips drifted away from the bond, somebody would trade one against the other.

That arbitrage is why strips are priced sensibly at all. They are not a separate market with its own supply and demand; they are a decomposition of one that already exists.

How this connects

Its reference point is yield to maturity. For a coupon bond that figure assumes each payment is reinvested at the same rate; here there is nothing to reinvest, so the quoted figure and the realized one coincide when the bond is held to the end.

Which removes reinvestment risk and keeps the rest. The structure swaps the danger of reinvesting coupons at lower rates for the danger of a large price move before maturity.

The yield curve decides what it pays. A long accrual bond is priced off the long end of the curve, so a rise in long-dated yields hurts it far more than a move in short rates.

Inflation is the quiet cost. The final sum is fixed in nominal terms, and a long stretch of rising prices erodes what it buys without touching the promised figure.

The issuer’s creditworthiness matters more than usual, because the whole claim rests on one payment the issuer must still be able to make at the end.

And the tax problem is usually solved by the wrapper. Inside a Roth IRA the accrued interest is not taxed year by year, while a bond ETF of long zeros keeps the price sensitivity but gives up the locked return, because the fund itself never matures.

When it fails

The characteristic failure is holding one without a matching liability. The instrument is bought for its locked return, and then rates rise sharply. A thirty-year accrual bond can lose a very large share of its market value on a move that costs a coupon bond a fraction of that, and the holder who needs to sell realizes the full loss. The locked return was always conditional on holding to maturity — that condition is the entire basis of the guarantee, and it is the condition most likely to break when the price has moved.

A second failure is ignoring the tax on phantom income, which is due whether or not cash arrives.

A third is underestimating the price sensitivity. These move far more than the maturity alone suggests.

A fourth is holding an accrual tranche without understanding prepayment, where the accrual period itself is uncertain.

The question: Down thirty percent. Hold twenty more years?

And a fifth is treating the credit risk as reduced. Nothing is received until the end, so the issuer’s survival matters for the whole term rather than being partly recovered through coupons.

Related

Bond duration covers the measure this structure maximizes. Bond convexity covers the second-order effect that is largest here. And corporate bond covers the credit exposure carried for the full term.

This page is educational, not financial advice. Test every idea on your own charts before risking money.