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. 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 >>
  2. 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 >>
  3. If I buy a $1,000 bond with a coupon of 10% and a maturity in 10 years, will I receive ...

    Simply put: yes, you will. The beauty of a fixed-income security is that the investor can expect to receive a certain amount ... Read Answer >>
  4. Why do bond coupon rates vary so greatly?

    Learn about the two major reasons that cause bond coupon rates to vary so dramatically and what role coupons play in the ... Read Answer >>
  5. How do you find accrued interest on a bond?

    Learn how to determine the accrued interest on a bond. The price in the secondary market reflects the accrued interest the ... Read Answer >>
Related Articles
  1. Personal Finance

    ‘Retired’ Too Soon? How to Reenter the Workforce After 50

    Here's what you need to know to survive financially and reenter the workforce when you're over 50 and a layoff has forced you to "retire" too soon.
  2. Financial Advisor

    Simple Math for Fixed-Coupon Corporate Bonds

    A guide to help to understand the simple math behind fixed-coupon corporate bonds.
  3. Investing

    5 Basic Things To Know About Bonds

    Learn these basic terms to breakdown this seemingly complex investment area.
  4. Investing

    Comparing Yield To Maturity And The Coupon Rate

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

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  6. Managing Wealth

    How Bond Prices and Yields Work

    Understanding bond prices and yields can help any investor in any market.
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. Clean Price

    A clean price is the price of a coupon bond not including any ...
  5. Coupon Bond

    A debt obligation with coupons attached that represent semiannual ...
  6. Current Coupon Bond

    A bond with a coupon rate that is within 0.5\% of the current ...
Hot Definitions
  1. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  2. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
  3. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  4. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  5. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  6. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
Trading Center