An accrual bond is a type of fixed-income security that does not pay periodic interest or coupon payments. The interest accrues and gets compounded over the life of the bonds and the principal as well accumulated interest are paid at maturity. The interest on these bonds is compounded semi-annually or annually.
An accrual bond is like a savings account where you do not withdraw the interest. The interest stays in the account and grows over time. At maturity, you get the original amount that is the principal as well as the interest it has earned.
Accrual bonds are used in finance as investment vehicles. They are attractive to investors who do not need immediate income but are looking for a guaranteed payout at a future date. These bonds are used by issuers such as governments or corporations as a way to manage cash flow as they do not require interest payment periodically.
Zero coupon bonds are a common type of accrual bond. In the case of a zero coupon bond, if an investor buys it for Rs. 500 which is less than its face value with a maturity of 10 years maturity, the investor will not get yearly interest payments. At the end of 10 years, on maturity, the investor will receive Rs. 1,000 at the end of 10 years.
Saving bonds are also a form of accrual bonds that are issued by the Government. They are purchased at a discount and redeemed at face value at maturity. The difference between the maturity value and face value is the interest that is earned.
Source: A to Z of Economics by Dr. NC Raghavi Chakravarthy