Accretion (of a Discount)
Accretion is the gradual increase in the value of an asset over time. The term is most commonly used when referring to debt instruments, such as bonds and notes, where accretion refers to the growth of the discount rate applied to face value. Accreted discounts are calculated by multiplying a security’s original issue price by its periodic interest rate for each period since issuance.
When a bond or note has been issued at less than par, that difference between par value and issue price is referred to as a “discount” which will be gradually accreted into income until it reaches zero when maturity date arrives. This process of reducing from discount amount to nothing is known as “accreting” or “accruing” discounts on debt securities. A company issuing these types of securities may also choose not to receive any cash flows associated with this payment until maturity date or they can opt out of receiving any payments at all if they wish.
The accrued discount increases over time due to compounding effect – meaning that every coupon payment adds up interest on top of previously accrued amounts which makes total amount continue growing until it reaches face value upon maturity date. For example, consider there’s 4-year bond with 10% annual coupon issued at $90 and face value being $100; after 1 year first coupon would be paid out making total return equal $9 plus previously discounted amount ($10), thus resulting in total return for investor standing at around 19%. Such calculation allows investors understanding exact returns generated through their investments even before redemption date arrives giving them more control over their portfolios performance assessment process .
In conclusion, accretion (of a discount) generally refers to gradual increase in debt instrument’s initial purchase cost towards its face value due compounding effect from regular coupons payments received along way till redemption point occurs making this concept one important factor helping investors understand expected returns prior investing into particular financial assets enabling them make better decisions about their money management strategies .
