What is a Day-Count Convention?
A day-count convention is the system used to calculate the amount of accrued interest or the present value when the next coupon payment is less than a full coupon period away. Each bond market and financial instrument has its own day-count convention, which varies depending on the type of instrument, whether the interest rate is fixed or floating, and the country of issuance. Among the most common conventions are 30/360 or 365, actual/360 or 365, and actual/actual.
Breaking Down Day-Count Convention
The day-count conventions apply to swaps, mortgages and forward rate agreements as well as bonds. Many of the rules and definitions for applying the day-count convention are set forth by the International Swap Dealers Association, which provides documentation for a wide range of financial transactions.
Deposits and Floating-Rate Notes
The interest on most money market deposits and floating-rate notes is calculated on an actual/360-day basis. The major exception is those denominated in the British pound, for which interest is calculated on the actual/365 basis. Currencies that are or have been closely related to the British pound, such as the Australian, New Zealand and Hong Kong dollars, also use 365 days.
The fixed-rate leg of an interest rate swap and most fixed-rate bonds use either the 30/360-day convention or 30/365. This convention stipulates the month will always be treated as having 30 days in it, and the year will consistently be treated as having either 360 or 365 days. Swap markets using the 30/360 convention for the fixed rate of a swap include the U.S. dollar, the euro and the Swiss franc. Swaps in the British pound and the Japanese yen usually use the 30/365 convention; Australia, New Zealand and Hong Kong again follow the United Kingdom.
The floating-rate leg of most interest rate swaps uses some variation of an actual day count versus either a 360 or 365-day year. The markets that use 30/360 for the fixed-rate leg, which include the U.S. dollar markets, use actual/360 for the floating-rate leg. Those that use 30/365 on the fixed-rate leg use actual/365 on the floating-rate leg.
Treasury Bonds and Notes
Bonds and notes issued by the U.S. Treasury earn interest calculated on an actual/actual basis. This means all days in a period carry equal value; it also means the length of coupon periods and the resultant payments vary.
LIBOR Day Count
The London Interbank Offered Rate (LIBOR) is the most commonly used benchmark interest rate, and is posted daily at 11:45 a.m. London time. For most currencies, interest at LIBOR is calculated on the actual/360-day basis; the major exception is again the British pound, which is calculated on the actual/365-day basis.