Dirty Price [CapiPedia]

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======Dirty Price======
Dirty Price (also known as 'Full Price' or 'All-In Price') is the actual price you pay or receive when you buy or sell a [[bond]]. Think of it as the final, out-the-door price, much like the total on your grocery bill after all the items are scanned. This price is 'dirty' not because it's involved in anything shady, but because it includes two components mashed together: the bond's market price and any [[accrued interest]] that the seller has earned but not yet been paid. When you look up a bond's price on a financial website, you're almost always seeing its [[clean price]]. The dirty price, however, is the real-world number that will actually move in or out of your brokerage account. Understanding this distinction is vital to avoid a common "sticker shock" moment for new bond investors and to accurately calculate your true returns.
===== Why Does the Dirty Price Even Exist? =====
The concept of a dirty price exists to ensure fairness between the buyer and seller of a bond. Most bonds make regular interest payments, known as [[coupon payments]], typically twice a year.
Imagine a bond that pays interest on January 1st and July 1st. If an investor sells that bond on April 1st, they have held it for three of the six months in that payment period. They've earned half of the next coupon, but the payment hasn't been made yet. Who gets that money?
This is where the dirty price comes in. The system is designed so that the //buyer// receives the full coupon payment on July 1st. To make things fair, the buyer must compensate the seller for the interest earned between January 1st and the sale date (April 1st). This compensation is the 'accrued interest' portion of the dirty price. It’s like buying a concert ticket from a friend halfway through the opening act – you pay them for the part of the show they already sat through.
===== The Clean vs. Dirty Price Showdown =====
Understanding the relationship between the clean and dirty price is key to navigating the bond market.
==== The Clean Price: The Headline Number ====
The clean price is the price of a bond without including the accrued interest. This is the price that is almost always quoted by brokers and financial news outlets.
Why use it? For clarity and comparability.
  * **Clarity:** The clean price moves based on fundamental factors like changing [[interest rates]], the issuer's [[credit risk]], and market sentiment. A bond's price graph looks smooth when plotting the clean price. If it plotted the dirty price, the graph would have a sawtooth pattern, gradually rising between coupon dates and then dropping sharply after a payment is made. This would make it incredibly difficult to see the underlying price trend.
  * **Comparability:** By stripping out the timing of interest payments, the clean price allows investors to compare the relative value of different bonds more easily.
==== The Dirty Price: The Real-World Cost ====
The dirty price is the settlement price—the amount of cash that changes hands. It's calculated with a simple formula:
**Dirty Price = Clean Price + Accrued Interest**
This is the number that truly matters for your cash flow and for calculating your investment's [[cost basis]].
===== A Practical Example: Buying a Bond =====
Let's see this in action. Suppose you want to buy a corporate bond with the following characteristics:
  * **[[Face Value]]:** $1,000
  * **[[Coupon Rate]]:** 6% per year (paying $30 every six months)
  * **Coupon Payment Dates:** January 1st and July 1st
  * **Quoted Clean Price:** 98 (meaning 98% of face value, or $980)
  * **[[Trade Date]]:** April 1st (exactly halfway through the coupon period)
Here’s how you’d find the dirty price:
  - **Step 1: Find the Clean Price.** The bond is quoted at 98, so the clean price is $980.
  - **Step 2: Calculate the Accrued Interest.** The next coupon payment is $30. Since you are buying the bond exactly halfway through the 6-month (approx. 182-day) period, the seller has earned half of that coupon.
  * Accrued Interest = $30 x (91 days / 182 days) = $15
  - **Step 3: Calculate the Dirty Price.**
  * Dirty Price = $980 (Clean Price) + $15 (Accrued Interest) = **$995**
So, while the bond was quoted at $980, you would actually pay $995 to purchase it. But don't worry—on July 1st, you will receive the full $30 coupon payment. This payment effectively reimburses you for the $15 in accrued interest you paid upfront, and you keep the other $15 as the return for holding the bond from April to July.
===== What This Means for Value Investors =====
For a practitioner of [[value investing]], precision is paramount. While the "dirty price" sounds messy, understanding it is about knowing exactly what you are paying for an asset.
  * **Know Your Cost:** The dirty price is your true cost basis. Getting this number right is the foundation for accurately calculating your [[yield to maturity]] and overall return on investment.
  * **No Surprises:** A value investor hates negative surprises. Knowing your transaction will settle at the dirty price, not the quoted clean price, prevents confusion and helps you manage your cash effectively.
  * **Focus on Value:** The ultimate goal of [[value investing]] is to buy a stream of future cash flows for less than its [[intrinsic value]]. The dirty price represents the immediate cash outflow required to secure that future stream. By understanding it, you ensure the first number in your valuation equation is the correct one, setting the stage for a sound investment decision.