28 Sep Portfolio Valuation

Portfolio Value

The value of a fixed income portfolio is comprised of two parts: the market value of the bonds and cash in the portfolio and the total amount of interest accrued, whether purchased or earned.

An Example

Consider the following example. On March 31, 2017, Investor A purchases a Treasury bond with a coupon of 1.5% and a maturity of March 31, 2023. On the same day, Investor B purchases a Treasury bond with a coupon of 1.5% and a maturity of February 28, 2023. Each investor paid par for their bonds.

A Quick Note on Accrued Interest

Bonds do not pay interest daily. For example, Treasury bonds pay interest just twice a year. However, the holder of a bond earns interest daily. As the interest is not paid daily, it accrues until a coupon payment date at which time all of the interest earned in the semiannual period is paid. If a bond is traded on any day other than the two payment dates, the purchaser of the bond will owe the seller the amount of interest which has accrued since the last payment date on the bond they are trading.

Back to the Example

If each investor has $100,000, Investor A would be able to purchase $100,000 par value for a cost of $100,000. As Investor A’s purchase date falls on an interest payment date, no accrued interest was due the seller. Investor B can only buy $99,000par value as 31 days of accrued interest totaling $125.10 would be due to the seller.

Assuming prices don’t change over the course of the following month, Investor A’s portfolio has a value of $100,122.95 on April 30, 2017, comprised of $100,000 market value of the bond plus $122.95 of earned interest. Investor B’s portfolio has amarket value of $100,121.05. Investor B’s bond has a market value of $99,000 and accrued interest of $246.15 ($125.05 of which is earned and $125.10 of which was “purchased”) as well as cash of $874.90 (left over after initial bond purchase).

It is interesting to note that if accrued interest is ignored, it appears as though Investor A is better off than Investor B.The value of Investor A’s portfolio appears to have remained at $100,000 while Investor B’s portfolio seems to have lost money, appearing to be just $99,874.90 (the value of the bond and remaining cash). This discrepancy disappears once accrued interest is taken into account.