Accrued Interest

A 150,000-dollar policy with a 10,000-dollar loan and 2,000 dollars of unpaid loan interest pays:

1. A.140,000 dollarsSubtracts the 10,000 loan but forgets the 2,000 of accrued unpaid interest. Interest that has accrued and gone unpaid is part of the policy indebtedness and comes out of the death benefit alongside the loan principal.
2. B.138,000 dollarsCorrect - benefit less loan and interest.
3. C.150,000 dollarsTreats the face amount as untouchable, as though a policy loan were an ordinary outside debt of the insured that the estate would settle separately. A policy loan is secured by the policy itself, so any balance outstanding at death is netted out before the beneficiary is paid.
4. D.128,000 dollarsUses the right rule but deducts 22,000, which means the loan or the interest was counted twice. The stem supplies only a 10,000 loan and 2,000 of unpaid interest, for 12,000 of total indebtedness.

Why: The death benefit is reduced by the loan plus accrued interest: 150,000 - 12,000 = 138,000.

Accrued interest on U.S. Treasury bonds is calculated on a(n):

1. A.No accrualInterest accrues on a coupon-bearing bond every day it is held, and the seller is compensated for the portion earned since the last payment date. Zero-coupon issues are the exception, and the stem describes Treasury bonds, which pay coupons.
2. B.Actual/actual basisCorrect - Treasuries use actual/actual.
3. C.30/360 basis30/360 is the convention for corporate and municipal bonds, treating every month as 30 days and the year as 360. Government issues are the carve-out and count the days that actually pass.
4. D.Actual/360 basisThis is a hybrid that counts real days but divides them by a 360-day year, and it belongs to money-market instruments rather than Treasury bonds. Mixing the two bases slightly inflates each day's accrual, since a real year runs longer than 360 days.

Why: Treasuries use an actual/actual day-count basis (corporates and munis use 30/360).

When a bond trades between coupon dates, accrued interest is:

1. A.ForgivenInterest already earned does not evaporate when ownership changes. The seller held the bond for part of the coupon period and is entitled to that share; forgiving it would hand the seller's earnings to the buyer.
2. B.Paid by the issuer to the buyerThe issuer pays the entire coupon to whoever holds the bond on the payment date and never splits it between the parties. Apportioning it is handled in the settlement between buyer and seller, and the issuer plays no part in that.
3. C.Paid by the seller to the buyerThe direction is reversed. The buyer will collect the whole next coupon, including the stretch the seller earned, so it is the buyer who hands that portion over at settlement and is made whole when the coupon arrives.
4. D.Paid by the buyer to the seller at settlementCorrect - buyer compensates seller for accrued interest.

Why: The buyer pays the seller the accrued interest earned since the last coupon date.

Accrued interest on most corporate and municipal bonds is computed on a:

1. A.365-day basis onlyThis reaches for the real calendar. Corporate and municipal accrual deliberately uses idealized 30-day months and a 360-day year so every interest period is uniform and the math is the same regardless of the month.
2. B.30/360-day basisCorrect - corp/muni use 30/360.
3. C.Actual/360 basisThis splices together halves of two different conventions, the real day count with the 360-day year. Actual/360 is a money-market convention, not the basis used for accrued interest on corporate and municipal bonds.
4. D.Actual/actual basisActual/actual is a real convention and is the right answer for U.S. Treasury notes and bonds, which is what makes it tempting. The stem asks about corporate and municipal issues, and those accrue on 30/360.

Why: Corporate and municipal bonds accrue interest on a 30/360-day basis; Treasuries use actual/actual.