What Is Compound Accreted Price (CAV)?
Compound accreted price (CAV) is a measure of the cost of a zero-coupon bond at a cut-off date prior to its maturity date. The CAV is calculated thru taking its distinctive gain price and together with the collected passion prior to now earned during the bondholder.
CAV is a useful metric for bond investors. Together with signifying the existing price of the bond, CAV can also be useful for working out whether or not or now not the bond issuer is liable to identify the bond. If the bond is called, this might energy the bondholder to advertise the bond once more to the issuer, receiving a cash price similar to the bond’s CAV.
Key Takeaways
- Compound accreted price (CAV) is a measure of the cost of a zero-coupon bond.
- It is continuously used to calculate the cost of such bonds prior to their maturity date.
- Bond issuers from time to time provide investors with a schedule of projected CAVs over the method the bond’s period of time. This knowledge can be useful to sit up for whether or not or now not the bond could be referred to as during the issuer.
How CAV Works
CAV is widely used among buyers and sellers of zero-coupon bonds. The ones unique investment vehicles do not pay passion all over their period of time, on the other hand instead accrue passion that is paid out at the bond’s maturity date. Put differently, zero-coupon bonds provide a return to investors thru allowing them to gain the bond at a substantial discount to its face price.
In some cases, the issuer would most likely provide a schedule of compound accreted values to investors in an respected remark. This file, in a position in connection with a primary offering, contains similar wisdom, similar to how the securities will probably be repaid and the financial characteristics of the issuer. This will likely have the same opinion investors quickly understand the projected price of the bond over the method its period of time, along with the creditworthiness of the borrower.
Calculating a zero-coupon bond’s CAV becomes in particular crucial if the bond carries a call provision. The verdict provision lets in the issuer to buy once more, or retire, the bond. It is because identify provisions for zero-coupon bonds are typically associated with the bond’s CAV. The availability will most often stipulate that the issuer can identify the bond on a decided on date at a worth which may be a most sensible elegance to the bond’s CAV. A nil-coupon bond is purchasing and promoting at a most sensible elegance if it costs more than its CAV at that specific cut-off date. Conversely, the zero-coupon bond is purchasing and promoting at a discount if it costs not up to its CAV.
Precise-World Example of CAV
For instance, consider the case of a 10-year zero-coupon bond with an interest rate of 10% in step with 12 months. Because of it is a zero-coupon bond, this instrument would no longer actually pay out its passion every 12 months. Instead, the investor would simply download a large buyout at the end of 12 months 10 reflecting the collected passion that was once earned (or “accrued”) throughout that time. Assuming an distinctive gain price of $1,000, for instance, this 10-year bond would pay out $2,593.74 at the end of its period of time. In numerous words, the bond’s CAV at the end of 12 months 10 can also be $2,593.74.
If the investor needs to advertise their bond forward of the highest of the period of time, then the bond can also be valued at its CAV, which is equal to the purchase price of the bond plus any collected passion that has been earned up to that cut-off date. If, for instance, the investor sells the bond at the end of 12 months 5, then its CAV can also be $1,610.51. Likewise, the CAV can also be lower if the bond were introduced earlier, and it could be upper if it were introduced later throughout the period of time.
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