Accrual rate
Accrual rate describes how often interest is accrued. For example, in case of credit cards it is accrued daily, while loans are usually accrued monthly. Every financial instrument that returns interest has accrual rate defined.
Accrual rate is important for calculations of interest and proper understanding of the price. The price of financial instruments like bonds on the market usually includes the interest.
It is also important whether the interest increases the principal or not. In case of daily accrual rate when interest increases principal the overall cost of the e.g. loan will be much higher than in case of monthly accrual rate.
Accrual rate calculation
To calculate daily accrual rate:
where:
- AR - accrual rate
- IR - annual interest rate
- 365 - days in year (warning: some lenders use 30-days months and then year is 360 days)
To calculate monthly accrual rate:
References
- Cox, J. C., Ingersoll Jr, J. E., & Ross, S. A. (2005). A theory of the term structure of interest rates. In Theory of Valuation (pp. 129-164).
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