The term accreted value refers to the value of an investment in which returns are reinvested throughout the investment term rather than paid out to investors.
While some investment vehicles such as savings accounts and regular bonds pay out interest to investors on a regular basis, other vehicles such as zero-coupon bonds and 3a retirement accounts reinvest interest back into the investment. The interest accrues until a predetermined date on which the investment matures and the invested capital is paid out to the investor along with interest earned.
If the investment vehicle allows for interest compounding – or earning interest on the accrued interest – the value of the investment at any point throughout the investment term is referred to as compound accreted value (CAV).
This term is most commonly used to denote the value of zero-coupon bonds. Unlike regular bonds which pay out interest on a predetermined basis in the form of coupon payments, the interest paid out by issuers of zero-coupon bonds on coupon dates is reinvested into the bond. Interest is accrued throughout the bond term and interest is paid on both the principal and the accrued interest (see: compounding interest effect).
The bond's accreted value accounts for accrued interest which is reinvested until the bond reaches maturity, at which point the face value of the bond plus accrued interest is paid out to the bond holder.
Example:
An investor buys a zero-coupon bond with a face value of 1000 Swiss francs, a 0.5 percent annual interest rate and a 5-year term.
The bond’s accreted value increases by 0.5 percent to 1005 francs when the interest for the first year of the term is added to the bond’s value. 2 years into the term, the accreted value of the bond is 1010.05 francs. After 3 years, the bond’s accreted value would reach 1015 francs. After 4 years, the bond would have an accreted value of 1020.15 francs and by the end of the 5-year term the final accreted value paid out to the investor would be 1025.25 francs. The amount paid out would be made up of the principal (1000 francs), accrued interest (0.5 percent of 1000 francs x 5 years = 25 francs) and compound interest earned on accrued interest (0.25 centimes).
If the investor were to buy a regular bond with the same face value, interest rate and term, they would receive their interest (0.5 percent of 1000 francs) in the form of annual, 5-franc coupon payments throughout the term (25 francs total). At the end of the bond term they would receive the face value of the bond (1000 francs).
See also:
Compound interest calculator
