Interest Income

Securities Which Pay Interest
Debt securities pay interest A debt security is an instrument issued by a corporation, the US Government, a government agency, or a municipality to raise capital The purchaser of a debt security has, in effect, made a loan to the issuer The amount of the loan is the principal amount of the security, and interest represents the cost to the issuer for use of the principal Debt issues are often accompanied by a supplementary indenture which defines the various terms of the loan,including the following:
*par value
* maturity date
* interest rate
* rate or index to which variable rate is tied
* interest payment dates
* any redemption rights or call privileges
* any principal paydown or sinking fund features





If the issuer of a security fails to either make a scheduled interest or principal payment or to meet some other provision of the security's indenture, that security is considered to be in default Default may lead to the issuer declaring bankruptcy Debt securities include corporate bonds and notes, USTreasury bonds and notes, municipal bonds, debentures, mortgage-backed securities, variable rate demand notes,commercial paper, US Treasury bills, domestic and Eurodollar certificates of deposit, banker's acceptances, and repurchase agreements

Accrual Basis
The accrual basis is a method used to account for interest earned on debt securities Interest is accounted for over the time period in which it is earned, regardless of when cash payment is received The number of days in a security's payment period must be determined in order to properly reflect the accrued interest Provisions for the accrual basis are stated in a security's indenture Most long-term (maturing in more than one year) debt securities accrue interest income for 30 days per monthover 360 days per year This is commonly known as "30/360" Others accrue interest for each day of the month over each day of the year This is known as "actual/actual" Most short-term (maturing in one year or less) securities accrue interest for each day of their life over a 360-day year This is known as "actual/360"
Accrual Basis Schedule
SECURITY
DAYS/MONTH
DAYS/YEAR
corporate bonds & notes
30
360
GNMAs/FNMAs/FHLMCs
30
360
banker's acceptances
actual
360
certificates of deposit
actual
360
commercial paper
actual
360
US treasury notes & bonds
actual
360
municipal bonds
actual or 30
actual or 360
VRDNs
actual or 30
actual or 360

Periodic Payments
Interest is paid by the issuer of a debt security as compensation for the issuer's use of money Interest payments are received at regular intervals that are determined when the security is first issued Interest payments on long-term securities are usually received periodically, on a monthly, quarterly, or semi-annual schedule Interest on short-term (money market) securities is usually received when the security matures However, interest on variable rate securities may be received monthly, quarterly, or semi-annually Once a corporation, municipality, or government agency has issued debt, it is legally obligated to make interest payments on each designated payment date, regardless of whether the issuer earns income or incursa loss

Payment Schedule
The chart below lists the frequency of interest payments for various types of securities SECURITY PAYS GNMAs/FNMAs/FHLMCs monthlyVRDNs monthly, quarterly or semiannually corporate bonds & notes semiannually municipal bonds semiannually US treasury notes & bonds semiannually banker's acceptances at maturity certificates of deposit at maturitycommercial paper at maturity US treasury bills at maturity

Fixed Vs Variable Rates
Securities issued at a fixed rate of interest accrue income at a constant interest rate for the life of thesecurity The interest rate is determined when the security is issued and does not change
Variable Rates
Variable rate securities are not issued at a specific interest rate Instead, the interest rate changes according to parameters specified when the security isissued The rates may change daily, weekly, or monthly, or when a specific index/rate to which the interest rate is tied (eg, the prime lending rate) changes The frequency of rate changes is determined when the security is issued Although rates change, payment dates do not Payments must be disbursed as specified in the indenture Variable rate securities are usually either municipal bonds or money market instruments, so both long-term and short-term securities may have variable rates These securities may also be known as floating rate items or variable rate demand notes (VRDNs)

Interest Bought And Sold
When a debt security is purchased or sold after issue date and between interest payment dates, interest is purchased from the previous owner, or is sold to the buyer, respectively This interest amount represents the interest that the previous owner has earned since the last payment date The previous owner receives this amount from the buyer upon settlement because, on the next payment date, the buyer will be the holder of record and will receive an interest payment for the entire pay period Interest bought is reflected in the following accounting entry:
DR Interest Receivable CR Payable for Investments Purchased
Interest sold is reflected in the following accounting entry:
DR Receivable for Investments Sold CR Interest Receivable

Interest Receivable
Interest Receivable represents interest that has been accrued and accounted for but not yet received in cash The Interest Receivable account on the Trial Balance is an asset account Its balance is affected by interest bought or sold, interest income accruals, and interest payments received Interest income is accrued and accounted for daily A fund is entitled to interest income on a debt security for each day that it holds that security Accounting for interest income is reflected in the following accounting entry:

DR Interest Receivable CR Interest Income
Interest payments represent income earned on an interest bearing debt security Interest is paid by the issuer of a security to the holder of record at periodic intervals that are determined when the security is issued The receipt of interest payments is reflected in the following accounting entry:
DR Cash CR Interest Receivable

Interest At Maturity
A debt security's maturity date is the date on which principal and all outstanding interest becomes due and payable Maturity date is determined when the security is originally issued Most long-term interest bearing securities and some short-term securities, such as variable rate demand notes (VRDNs), have regularly scheduled interest payment dates Only the final interest payment will be received with the principal payment when these items mature, since the holder of the security has received interest payments throughout the life of the security In contrast, all of the interest that has been accrued on most short-term securities is received when the security matures In either case, the following accounting entry records a security's maturity:

DR Cash CR Cost CR Interest Receivable
How Money Is Received
Interest payments are received from the issuer at periodic intervals which are determined for each security at the time of issue All payment documentation must be maintained in the Fund's files
Payment Methods
Interest payments can be received through a variety of channels, including: Depository Trust Company (DTC) Fed Book Entry (FBE) Participants Trust Company (PTC) Wires Lockbox Complete On-line Method Portfolio Appraisal Safekeeping System (COMPASS) Checks
DTC
Notification of payments received for securities held in DTC is received by the PA in the form of a DTC Dividend and Interest Income sheet DTC dividend and interest payments are credited to the Fund's DDA by the DTC Unit in the Quincy Securities Processing area
FBE
Payments for FBE items are made through the FBE System The Fed desk notifies the PA of income received via a Fed 3E sheet In order for the payment to be deposited into the Fund's DDA, the PA must submit a DDA credit ticket to the Fed desk in the Quincy Securities Processing area
PTC
The PA receives a PTC Principal & Interest Report as notification of principal and interest payments that are made on mortgage backed securities held in PTC The PA must submit a DDA credit ticket to the PTC desk in Quincy Securities Processing in order for the payment to be deposited in the Fund's DDA
Wires
Payments sent to the Bank via Fed wire are deposited to a central account, the Master Money Transfer Account (MMTA) The monies are transferred from the MMTA account to the appropriate mutual fund DDA, usually by the Wire Processing Unit The PA receives a hard copy of the wire either the same day or the next day, which identifies the monies deposited in the DDA
Lockbox
Many banks offer Lockbox services which collect, deposit, and credit monies fast and efficiently, reducing mail float by operating close to major money center banks State Street uses Midlantic Bank in Jersey City, New Jersey, as its Lockbox bank Midlantic Bank wires the money it has collected to State Street and sends photocopies of the checks as a backup Quincy Securities Processing collects the payments and distributes payment notification to the appropriate Portfolio Administrator (PA) In order to collect the income, the PA submits a Demand Deposit Account (DDA) credit ticket to the Lockbox desk located in the Quincy Securities Processing area The payment amount is then deposited in the Fund's custodian account, and the PA receives the photocopy of the check sent by Midlantic Bank

Compass
COMPASS, a computer system unique to State Street Bank ,is used to collect interest on coupon bonds held in the Boston Vault The COMPASS system produces a coupon cutting slip which is the Vault's notification and authorization to detach and submit the coupon for collection Payments received for revolving notes or overnight investments held in Boston are sent through COMPASS Quincy Securities Processing distributes notification of COMPASS payments to the appropriate PA In order to collect the income, the PA must submit a DDA credit ticket to the Lockbox desk located in the Quincy Securities Processing area The payment amount is then deposited in the Fund's custodian account

Checks
Checks are sent by paying agents through the mail to the Bank Once received, the checks are sorted in the mail room according to the Fund's nominee name The check is then forwarded to the First Line Manager - Securities & Cash Processing The PA must deposit the check to the DDA using a deposit ticket