Accretion is the process of gradually increasing the book value of a bond that was purchased at a discount.
When you buy a bond below its face value — say you pay $950 for a $1,000 bond — that $50 gap doesn’t just sit there. Over time, the bond’s value on your books slowly climbs back up toward $1,000 by maturity. That gradual climb is accretion.
Think of it as the opposite of amortization. While amortization writes down the premium on a bond bought above par, accretion writes up the discount on a bond bought below par.
The Exam Definition
Accretion is the annual upward adjustment of a discount bond’s cost basis toward par value over the life of the bond. Each year, the book value increases by a set amount until it reaches face value at maturity.
- Applies to bonds purchased at a discount (below par)
- Book value increases gradually toward par over time
- Raises the investor’s cost basis each year
- The opposite of amortization (which applies to premium bonds)
- Tested on both the SIE and Series 7
Why It Matters for the Series 7 and SIE
Accretion affects the cost basis of your bond. Each year, as the book value increases, your cost basis goes up too. That means when you eventually sell or the bond matures, your taxable gain is smaller — because you’ve been recognizing part of that gain each year along the way.
Here’s why this trips people up on the exam: most people think about bonds in terms of coupon payments and yield. But accretion is about what’s happening to the book value — not the cash you’re receiving. A zero-coupon bond is the clearest example. You receive no coupon, but accretion still happens every year, and you still owe taxes on the phantom income.
The exam will test whether you know the direction (up for discounts, down for premiums), what it affects (cost basis), and when it matters (at sale or maturity). Nail those three things and you’ll handle any accretion question they throw at you.
Real Exam Scenarios
Scenario 1 — The Basic Calculation
An investor buys a $1,000 par bond for $900 with 10 years to maturity. What is the annual accretion amount?
The discount is $100 ($1,000 – $900). Divided by 10 years = $10 per year. Each year, the cost basis increases by $10. By maturity, the cost basis reaches $1,000. The exam may give you this in a straight-line calculation — just divide the discount by the years remaining.
Scenario 2 — Tax Treatment
A client holds a corporate bond purchased at a discount. She asks whether she’ll owe taxes before the bond matures. What do you tell her?
Yes — for corporate bonds, accretion is treated as ordinary income each year, even if no cash changes hands. This is the “phantom income” problem. Municipal bond discounts work differently (OID rules apply), but corporate bond accretion is taxed annually. The exam tests whether you know the difference.
Scenario 3 — Accretion vs. Amortization
A question describes a bond purchased above par. It asks what happens to the book value over time. Is that accretion or amortization?
Amortization. Premium bonds (bought above par) have their book value written down over time. Discount bonds (bought below par) have their book value written up — that’s accretion. The direction is the key. Don’t mix them up.
Common Traps and Misconceptions
Trap 1: Confusing accretion with amortization. These are mirror images. Accretion = discount bond, book value goes up. Amortization = premium bond, book value goes down. The exam will present both and ask you to identify which applies. Keep the direction straight.
Trap 2: Thinking no taxes are owed until maturity. For corporate bonds, annual accretion is taxable as ordinary income — even in years when no cash is received. This surprises a lot of candidates. Know it cold.
Trap 3: Forgetting that cost basis changes. As the book value accretes upward, the cost basis rises too. If a client sells the bond before maturity, the gain or loss is calculated against the adjusted cost basis, not the original purchase price.
Trap 4: Applying this only to coupon bonds. Zero-coupon bonds are the most extreme accretion example — no cash flow, but maximum accretion each year. The exam loves zero-coupon bond questions precisely because the phantom income and accretion concepts are most visible there.
Related Concepts
Accretion connects directly to several other bond concepts you’ll see on the exam:
Amortization — The mirror of accretion. Applies to premium bonds. Book value decreases toward par over time. Reduces the cost basis annually.
Accrued Interest — Different concept entirely. Accrued interest is the interest earned but not yet paid between coupon dates. The buyer pays it to the seller at settlement. Don’t mix it up with accretion. → See: What is Accrued Interest?
Yield to Maturity (YTM) — Discount bonds have a YTM higher than their coupon rate, which is part of the reason accretion matters — the total return includes both the coupon and the gain from discount to par.
Keep Studying
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Related Terms:
→ What is Accrued Interest?
→ What is Ad Valorem Tax?
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