Bond Valuation With Accrued Interest: A Closed-Form Solution

The received orthodoxy of teaching bond valuation to our introductory students typically assumes that an annual or semiannual coupon payment occurs on the day the bond is being priced. Though such an approach is an obvious pedagogical convenience to the professor, most students do not recognize that the method is only applicable for at most one or two working days of the year. The solution to this problem entails an understanding of accurate, "flat" bond pricing and practice. Unfortunately, the formulae used to accurately price bonds are complex and are likely to overwhelm the introductory student. In an attempt to alleviate this problem, this paper details a functional closed-form equation for pricing bonds that works regardless of coupon timing and is based solely on the basic principles of the time value of money.