Accreted Value - Explained
What is Accreted Value?
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Table of ContentsWhat is Accreted Value?How does Accreted Value Work? What to Consider when Assessing an Accreted ValueImportance of an Accreted Value to Bond PricingAcademic Research on Accreted Value
What is Accreted Value?
Accreted value is a value that accumulates interest, but will not pay out that interest at any given time until it reaches maturity. Accreted value is commonly applied on zero-coupon bonds or on cumulative preferred stock.
How does Accreted Value Work?
Some investment interest plans like savings accounts and other regular bonds are usually shared out to investors on a regular basis. On the other hand, investment plans like zero-coupon bonds, do not share out their interests. Instead, the interest is reinvested and it accrues value until a certain period of maturity time. Accreted value is the amount that accrues its interest but the interest is not shared among investors until it reaches maturity. This best applies to zero-coupon bonds and stock markets. The investors then get the capital they invested plus the interest the bond earned during its maturity time.
With respect to capital appreciation bonds, accreted value is the amount that is equal to the original amount added to the interest which the bond has accrued. This is counted from the date the bond was issued to the date it was computed. Accreted value of a bond at a particular time equates to the initial amount invested, plus the accumulated interest over the period of time to that very date. Normally, zero-coupon bonds are discounted when being issued. The value then increases gradually during the life of the bond. So, the accreted value may be lower or higher than the bonds market value. However, this is never an issue as its market value is accredited to the supply and demand of the bond based on its worthiness. The worth of the bond may change during its lifetime making the market value to rise or fall. Generally, an accreted value of a bond does not relate to its market value, although the two sometimes have a tough relationship. A bonds accreted value grows mathematically and its final value may turn out to be higher than its market value at a certain period in time. If the market value of the bond happens to fall, the accreted value of the bond will be higher than the market value. But if the market value of the bond rises, then the accreted value of the bond will be less.
What to Consider when Assessing an Accreted Value
There are some elements that are put into consideration when assessing an accreted value. They are as follows:
- The initial price offering for the bonds. This is basically the investors initial capital when the offer is being made during investment.
- The interest that has accumulated throughout the bonds lifetime (until maturity time). This is also based on the agreed interest rates at the initial offering of the bond.
Importance of an Accreted Value to Bond Pricing
An accreted value may be relevant on bond pricing in the following ways:
- It is a factor used to determine the capital appreciation bonds weighted average mature.
- It is viewed as on bond theoretical pricing. This is if it was to be sold while the market interest rates continued to be consistent in their recent level.
- The accreted value is the amount that accrues its interest, but the interest is not shared among investors until it reaches maturity.
- The accreted value applies best to zero-coupon bonds and stock markets.
Academic Research on Accreted Value
- Cash-settled convertible bonds and the value relevance of their accounting treatment, Lewis, C., & Verwijmeren, P. (2014). Cash-settled convertible bonds and the value relevance of their accounting treatment. Journal of Corporate Finance, 24, 101-111. Cash settlements became a popular design feature in convertible securities once they obtained favorable accounting treatment for diluted earnings per share in 2002. The unexpected proliferation of cash settlements provoked the FASB to eliminate their favorable accounting treatment in 2008. We find that shareholders of firms that use cash-settled convertibles react negatively to the announcement of these recent changes. Firms that issued cash-settled convertible debt to avoid earnings dilution no longer have an incentive to keep them on their balance sheets. Consistent with this observation, we find that investors respond more favorably if the cash-settled convertibles of these firms include call features. We conclude that call features can be valuable in times of uncertainty related to possible accounting changes as they allow the firm to efficiently mitigate the effects of the accounting changes on their financial reporting.
- On the call provision in corporate zero-coupon bonds, Narayanan, M. P., & Lim, S. P. (1989). On the call provision in corporate zero-coupon bonds. Journal of Financial and Quantitative Analysis, 24(1), 91-103. A majority of corporate zero-coupon bonds includes a call provision, giving the firm the right to call the bond at par value. In this paper, we investigate whether or not it is optimal for the firm to call such a bond for refunding purposes, taking into consideration the effect of corporate taxes. We find that it is not optimal to refund the bond as long as the corporate tax rate is less than 50 percent. We find that a significantly higher proportion of callable zero-coupon bonds, compared to noncallables, has restrictive financing covenants, suggesting that the call feature is included to provide flexibility at a low cost for future recapitalizations as the firm's investment opportunities change.