Explain Interest Rate Accrual
Interest rates compensate lenders for taking on the risks of lending money. Borrowers make regular payments that return the principal with interest to creditors. Interest-rate accrual accounts for the growth of interest between payments.
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Features
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Making and receiving interest payments every millisecond is not feasible. Interest is typically paid on a monthly or semiannual basis. Although interest is not paid daily, it grows in between payment dates. This growth is referred to as the accrual.
Identification
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Bonds, savings accounts, mortgages and credit card debt are financial instruments that accrue interest. Interest accrual is particularly important to principal-only investments that are bought at a discount. Zero-coupon bonds, for example, are Treasurys that do not make interest payments. Investors buy these securities for less than face value and interest accrues until the face value is paid out at maturity.
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Considerations
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Interest builds upon itself, or compounds over time. For example, a $1,000 account paying 10 percent annual interest becomes $1,100 in one year. After two years, the account balance is $1,210--including $110 interest earned on $1,100 that second year. The account accrues less than $10 worth of interest each month.
Misconceptions
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Interest may have accrued on your account, but no money changes hands until a payment is made.
Risks
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Accrued interest reported as earnings may be misleading. Accrued interest may never be received because of default.
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References
Resources
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