Clean Price vs Dirty Price: Meaning, Differences and Examples Explained

Understanding the difference between clean price vs dirty price is essential for investors, as it affects the determination of a bond’s price when they trade in the secondary market. More specifically, how do clean and dirty prices differ?

A common phrase in bond markets is, “Buy clean, pay dirty.” As explained above, the clean price represents the bond’s value, excluding any accrued interest, while the dirty price includes both the clean price and accrued interest owed to the seller.

Knowing this distinction is crucial for investors, as it impacts investment decisions and portfolio profitability. Let’s explore clean and dirty prices, their differences, and an example to clarify their significance.

What is the Clean Price? 

The clean price of a bond is simply market price excluding accrued interest. It denotes the bond’s intrinsic value without considering the interest accrued since the last coupon payment. This price is commonly used in bond market quotations.

Following are some key features of Clean Price:

• Clean price is also called the flat price or quoted price.
• Used for computing bond yields and comparing bond prices.
• Excludes accrued interest, providing a clearer picture of a bond’s actual worth.
• Quoted in financial markets to ensure standardised pricing.

The clean price standardises bond trading, making it easier to compare different bonds without the complications of accrued interest. Even if a bond approaches a coupon payment date, its clean price remains unchanged in market quotations.

What is the Dirty Price? 

The dirty price of a bond consists of the clean price plus any accrued interest since the last coupon payment. It is the actual amount an investor pays when purchasing a bond through the secondary market.

Following are some key features of Dirty Price:

• It is also known as the full price or settlement price.
• Includes accrued interest accumulated between coupon payments.
• Represents the total cost an investor incurs when buying a bond.

The Formula for Dirty Price:

Dirty Price = Clean Price + Accrued Interest

Accrued interest is calculated using the formula:

Accrued Interest = (Coupon Rate × Face Value × Days Since Last Payment) / Total Days in Coupon Period

Difference Between Clean Price Vs Dirty Price 

The main distinction between clean and dirty prices lies in accrued interest:

Clean price is used to quote bond prices in financial markets, while dirty price is used to settle.

Also, clean price excludes interest, whereas dirty price includes accrued interest owed to the seller.

Clean price provides a standardised value for easier bond comparison, whereas dirty price represents the actual amount an investor pays.

Example of Clean and Dirty Price 

Let’s assume an investor is buying a bond with the following details:

• Face Value: Rs 1,000
• Coupon Rate: 10% annually
• Time Since Last Coupon Payment: 180 days
• Total Coupon Period: 360 days
• Clean Price: Rs 980

Step 1: Calculate Accrued Interest on the Bond

Accrued Interest = (10% × Rs 1,000 × 180) / 360 = Rs 50

Step 2: Calculate the Dirty Price of the Bond

Dirty Price = Clean Price + Accrued Interest

Dirty Price = Rs 1,000 + Rs 50 = ₹1,050

Thus, while the clean price of the bond is Rs 980, the investor pays Rs 1,030 due to accrued interest.

Conclusion

Knowing the difference between clean price vs dirty price is essential from an investors’ point of view. The clean price is used for market quotations and comparing bonds. Whereas the dirty price is what investors incur, it consists of accrued interest. This distinction helps investors make informed decisions when trading in bonds in the secondary market. By knowing how these prices work, investors can better assess bond values, plan their purchases, and manage their investment portfolios effectively.