Series 7 Exam Question 29: Answer and Explanation

Question: 29

Declan K. purchased a 5% ABC Corporate bond on Monday, May 10th with coupon dates January 1st and July 1st. How many days of accrued interest does Declan owe?

• A. 129 days
• B. 130 days
• C. 131 days
• D. 132 days

Correct Answer: C

Explanation:

C. Accrued interest takes place when a bond trades in between coupon dates. Corporate and municipal bonds assume a 30-day month and a 360-day year. Accrued interest is calculated from the previous coupon date up to, but not including the settlement date. So first, you have to get the settlement date. Since Declan purchased the bond on Monday, May 10th, you don't have a weekend to contend with. Because corporate bonds settle in two business days, the settlement date is Wednesday, May 12th (5/12). Next, find the previous coupon date, which is January 1st (1/1). Now set up the equation:

$\frac{\begin{array}{l}5/12\\ -1/1\end{array}}{4/11}$

(4 months × 30-day months) + 11 days =131 days of accrued interest

First subtract the fifth month (May) from the first month (January). You end up with four months. Because corporate and municipal bonds calculate accrued interest using 30-day months, you have to multiply four months by 30 days to get an answer of 120 days. Subtract the previous coupon date (1) from the settlement date (12) to get an answer of 11 days. Add the 120 days and 11 days together, and you get 131 days as your answer.