Compound Accreted Value (CAV)
Contents
Understanding Compound Accreted Value (CAV) in Bond Investments
Exploring Compound Accreted Value
Compound accreted value (CAV) serves as a vital metric in the realm of bond investments, particularly concerning zero-coupon bonds. It signifies the value of a zero-coupon bond at a specific point before its maturity date, determined by adding the accrued interest to the original purchase price.
Key Aspects of CAV
Zero-coupon bonds, known for not paying interest during their term, rely on accrued interest that is disbursed upon maturity. CAV aids investors in gauging the current worth of the bond and anticipating potential calls by the issuer. Bond issuers may provide projected CAV schedules to offer insights into the bond's value trajectory.
The Mechanics of CAV
For zero-coupon bonds with call provisions, CAV plays a pivotal role as call prices are often tied to this value. Understanding CAV becomes crucial for investors considering the implications of selling the bond before maturity. A bond is deemed to trade at a premium if its cost surpasses its CAV and at a discount if it falls below.
Illustrating CAV with an Example
Consider a scenario involving a 10-year zero-coupon bond with a 10% annual interest rate. While the bond doesn't yield interest annually, it accrues interest over the term, resulting in a significant payout at maturity. Calculating the CAV allows investors to assess the bond's value at different points in time, influencing their investment decisions.