Overview

This processing document will explain the computation of accrued income for bonds at the position level. It will show information on position accruals for bonds that have been purchased, bonds that are currently held, and bonds that are being sold.

Purchase of a Bond

When purchasing a bond, the buyer must buy the accrued income through the day before settlement date. The bond will then start accruing on settlement date of the trade.

Example

Bond A

• 9% Coupon Rate

• Pays Semiannually on 1/15 and 7/15

• 30/360 Day Count

• Issue Date = 1/15/2005

• Maturity Date = 1/15/2025

• Issue Price = 100

Purchase 4,000,000 Par of Bond A

• Trade Date = 2/17/2009

• Settle Date = 2/20/2009

• Purchase Price = 100

Transaction Details

Calculation of Income Purchased

• 4,000,000 (par) * .09 (coupon) = 360,000 Annual Income Amount

• 360,000 / 360 = 1,000 Daily Income Accrual

• Last Payment Date was 1/15/2009: compute number of days in current accrual period (16 in January and 19 in February). There are 16 days in January because the day count begins on pay date 1/15/2009 and ends on 1/30/2009. The 19 days in February are counted from 2/1/2009 through the day before settle date (2/19/2009).

Position Information

As the bond purchase is processed and generates the bond position, there is a corresponding generation of a cash position for the portfolio. In this example, assume that the portfolio started with 6,000,000 in cash prior to the bond purchase.

Accrued Income at the position level is computed as follows:

• Accrued Income Earned (in the current period) + Interest Purchased (in the current period) - Interest Sold (pending settlement)

Notes

• The price of the bond in these examples is held constant at 100, but in actual practice, price fluctuations would be incorporated into the daily market value of the bond and subsequently incorporated into the performance computations.

• The daily accrued income earned in these examples is 1,000 for ease of understanding.

Position Information for Cash Balance

For the above example, performance calculations are straight forward and returns can be computed for the bond position, cash balance, and the total portfolio. (Note: for simplicity the price of the bond is held constant at 100, but price fluctuations would be incorporated into any return calculation).

The 0% returns for the bond and total fund until 2/19/2009 are indicative of the fact that the portfolio has pre-paid for interest through 2/19/2009 and does not begin accruing interest until 2/20/2009. On 2/20/2009, the returns reflect the earning of the daily interest accrual of 1,000.

Valuation

Sale of a Bond

When a bond holding is sold, the accrued interest on the sale transaction is also computed through day before settlement date.

Using the same example as above, we can generate a sale of the entire position.

• Trade Date = 5/11/2009

• Settle Date = 5/14/2009

• Sale price = 100

Transaction Details

Calculation of Income Sold

• 4,000,000 (par) * .09 (coupon) = 360,000 Annual Income Amount

• 360,000 / 360 = 1,000 Daily Income Accrual

• Last Payment Date was 1/15/2009: compute number of days in current accrual period (16 in January, 30 in February, 30 in March, 30 in April, and 13 in May).

Position Information on a Traded Basis

The Accrued Income for the Position is computed as follows:

Accrued Income Earned (in the current period) + Interest Purchased (in the current period) - Interest Sold (pending settlement)

As the bond sale is processed and generates the change in the bond position, there is a corresponding generation of a cash position for the portfolio. In this example, the portfolio had 1,965,000 prior to the sale being posted.

Position Information for Cash Balance

For the above example, performance calculations for the cash balance remain straight forward and returns can be computed for the cash balance and the total portfolio. However, the returns for the bond position need special logic to compute daily returns at the individual bond level. (Note: for simplicity the price of the bond is held constant at 100, but price fluctuations would be incorporated into any return calculation).

Valuation

The positive returns for the total fund from 5/11/2009 through 5/14/2009 are indicative of the fact that the portfolio is still earning interest through 5/13/2009. The negative accrued income at the bond position level reflects the fact that the interest sold is larger than the actual income earned from the period of trade date through settlement date - 1. The movement of this value to 0 shows the daily accrued income earned for each day leading up to the settlement of the sale. While the negative accrued income balance may some intuitively obvious at first glance, the above example shows that the negative balance offsets the income portion of the receivable from the sale. This receivable is already incorporated into the traded cash balance and needs to be offset at the security level until the income is actually earned. This allows for an accurate daily return at the total fund level instead of crediting multiple days' worth of income into one day and overstating that day’s return.

Custom Return Calc

Custom return logic is required to accurately compute the individual bond return during the settlement period of the sale, and will be defined in a future version of this document.