What it means
Most bonds pay interest at set dates, and between those dates interest builds up for the seller. When a normal bond is sold, the buyer pays the quoted price plus the accrued interest, and then receives the full coupon at the next payment date.
This is called trading with accrued interest. A flat bond trades "flat", which means the accrued interest is not added to the price.
The most common reason is that the issuer is in financial trouble and has missed payments, so there is no reliable interest to share between buyer and seller. Any interest that might eventually be paid is simply priced into the bond's value.
Zero-coupon bonds also trade flat, but for a different reason. They pay no regular interest at all and instead are sold at a discount to face value, so there is nothing to accrue.
The return comes entirely from the price rising towards face value by maturity. For finance professionals, the distinction matters for settlement, accounting and pricing.
The cash needed to settle a trade is higher for a normal bond than for a flat one with the same quoted price. Bond prices in many markets are quoted "clean", meaning without accrued interest, and the "dirty" price adds the accrued interest.
A key risk with flat bonds is that the buyer may never receive the missed interest. If the issuer restructures, bondholders might be offered new bonds or shares for less than the amount owed.
Anyone buying a flat bond in default should understand the legal rights of bondholders and the likely recovery. In accounting, the treatment follows the same split.
A holder of a performing bond records accrued interest as income as it builds up, while a holder of a flat bond that has stopped paying usually stops recognising interest income and assesses whether the bond has lost value. Auditors will want evidence for that judgement.
In practice
Real-world examples.
Example
A distressed fund buys the defaulted bonds of a bankrupt retailer at 30 cents on the dollar. The bonds trade flat, so the fund pays only the quoted price and takes the risk of recovering any missed interest through the restructuring.
Example
A pension fund holds a zero-coupon bond bought at $70,000 for a $100,000 face value. There is no interest to accrue, so when the fund sells, it receives only the quoted price.
Example
A corporate treasurer is asked to value a portfolio including a bond in default. The accounting team confirms the bond trades flat, so no accrued interest receivable is booked on the balance sheet and the carrying value is reviewed against the quoted price instead.
Formula
Calculation
Settlement amount = Quoted price + Accrued interest (not added when a bond trades flat)
Accrued interest = Face value x Coupon rate x Days since last coupon / 360
Suppose an investor buys $100,000 face value of a bond quoted at 98. The quoted price is 100,000 x 0.98 = $98,000. If the bond is a healthy 6% coupon bond with 60 days of accrued interest, accrued interest = 100,000 x 0.06 x 60 / 360 = $1,000, so the investor pays $99,000. If the bond trades flat, the investor pays only the $98,000.Case study
Seen in the real world.
Bluestone Energy is an illustrative, fictional company that missed two coupon payments on its bonds after a fall in the price of its main product. The bonds began to trade flat, with buyers offering a price that already allowed for the chance of little or no interest being paid.
A specialist investor bought a block of the bonds at a deep discount, studied the company's assets and joined the creditor committee in the restructuring talks. After an agreement, bondholders received new bonds with lower interest and a smaller amount of shares.
The illustrative outcome was a recovery well below the original claim, but above the purchase price. The lesson is that flat bonds can be profitable for those who study the issuer's assets, though they can lose heavily for those who do not.
Watch out
Common mistakes.
- Assuming a flat bond has no value, when the market price reflects the expected recovery.
- Expecting to receive a share of unpaid past interest after buying a bond that trades flat.
- Confusing a flat bond with a flat yield curve, which describes similar interest rates across different maturities.
Questions
People also ask.
What does "trading flat" mean?
It means the buyer pays the quoted price with no separate amount for accrued interest, so the price alone is the full cost of the purchase.
Do all defaulted bonds trade flat?
Most do, though the market convention can vary, so confirm the terms with the broker or dealer before settlement.
Is a zero-coupon bond a flat bond?
It trades flat because it has no coupons to accrue, although it is not in default.
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