A:

A day-count convention is a system used in the bond markets to determine the number of days between two coupon dates. This system is important to traders of various bonds because it affects how the accrued interest and present value of future coupons is calculated.

The notation used for day-count conventions shows the number of days in any given month divided by the number of days in a year. The result represents the fraction of the year remaining that will be used to calculate the amount of future interest owed. Here are the most common day counts used in bond markets and the securities to which they typically apply:

30/360 - This is the easiest convention to use because it assumes that there are 30 days in every month, even though some months actually have 31 days. For example, the period from May 1, 2006 to August 1, 2006 would be considered to be 90 days apart. Given the simplicity of this day-count convention, it is often used in calculations of accrued interest for corporate, agency and municipal bonds. It is also commonly used by investors of mortgage-backed securities.

Actual/360 - This convention is most commonly used when calculating the accrued interest for commercial paper, T-bills and other short-term debt instruments that have less than one year to expiration. It is calculated by using the actual number of days between the two periods, divided by 360.

Actual/365 - This convention is the same as the actual/360, except that it uses 365 as the denominator. This is used when pricing U.S. government Treasury bonds.

Actual/Actual - This convention uses the actual number of days between two periods and divides the result by the actual number of days in the year, rather than assuming that each year is made up of 360 or 365 days. Of course, we know that in reality there are always 365 days in a year - with the exception of leap years - but these conventions are standards that have developed over time and help to ensure that everyone is on an even playing field when a bond is sold between coupon dates.

To learn more, see our tutorials on Bond Basics and Advanced Bond Concepts.

RELATED FAQS
  1. How does a bond's coupon interest rate affect its price?

    Find out why the difference between the coupon interest rate on a bond and prevailing market interest rates has a large impact ... Read Answer >>
  2. What is accrued interest, and why do I have to pay it when I buy a bond?

    A bond represents a debt obligation whereby the owner (the lender) receives compensation in the form of interest payments. ... Read Answer >>
  3. How do I calculate yield in Excel?

    Learn about yield as it pertains to bonds and how to calculate this prospective valuation of an investment's total return ... Read Answer >>
  4. How does a bond's coupon rate affect its price?

    Find out how a bond's coupon rate influences its price, including the role of government-dictated interest rates and the ... Read Answer >>
  5. How do debit spreads impact the trading of options?

    Find out what it means when a bond has a coupon rate of zero and how a bond's coupon rate and par value affect its selling ... Read Answer >>
  6. How does the effective interest method treat the interest on a bond?

    Find out why you should look at the effective interest of a bond rather than simply relying on its stated coupon rate when ... Read Answer >>
Related Articles
  1. Bonds & Fixed Income

    Advanced Bond Concepts: Bond Pricing

    It is important for prospective bond buyers to know how to determine the price of a bond because it will indicate the yield received should the bond be purchased. In this section, we will run ...
  2. Investing Basics

    Explaining the Coupon Rate

    Coupon rate is the stated interest rate on a fixed income security.
  3. Bonds & Fixed Income

    Understanding Bond Prices and Yields

    Understanding this relationship can help an investor in any market.
  4. Bonds & Fixed Income

    Advanced Bond Concepts: Yield and Bond Price

    In the last section of this tutorial, we touched on the concept of required yield. In this section we'll explain what this means and take a closer look into how various yields are calculated. ...
  5. Investing Basics

    What is a "Coupon"?

    In the financial world, “coupon” represents the interest rate on a bond.
  6. Bonds & Fixed Income

    5 Basic Things To Know About Bonds

    Learn these basic terms to breakdown this seemingly complex investment area.
  7. Bonds & Fixed Income

    Simple Math for Fixed-Coupon Corporate Bonds

    A guide to help to understand the simple math behind fixed-coupon corporate bonds.
  8. Bonds & Fixed Income

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  9. Investing Basics

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  10. Retirement

    Bond Basics: Characteristics

    Bonds have a number of characteristics of which you need to be aware. All of these factors play a role in determining the value of a bond and the extent to which it fits in your portfolio. Face ...
RELATED TERMS
  1. Day-Count Convention

    A system used to determine the number of days between two coupon ...
  2. Bank Discount Basis

    A quoting convention used by financial institutions when quoting ...
  3. Flat Bond

    A debt instrument that is sold or traded without accrued interest, ...
  4. Zero-Coupon Bond

    A debt security that doesn't pay interest (a coupon) but is traded ...
  5. Required Yield

    The return a bond must offer in order to be a worthwhile investment. ...
  6. Step-Up Bond

    A bond that pays an initial coupon rate for the first period, ...
Hot Definitions
  1. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  2. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  3. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  4. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  5. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
Trading Center