Day-Count Convention
A Day-Count Convention is a system that determines the number of days that interest accrues between coupon payment days. It is used in a variety of debt securities such as bonds, mortgages, swaps, and forward rate agreements (FRAs).
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For interest-earning investments, if transactions are not made on the coupon installment dates, the accrued interest should be thought about. A day-count convention can be utilized to figure an accrual factor by specifying how to count the days of an entire coupon period and the days of an accrual period.
Types of Day-Count Convention:
There are two major types of day-count conventions:
- Actual method:
In this method, the actual no. of days should be counted in the accrual period or the coupon payment days. The actual/actual method uses the real no. of days in every month and year, which requires an accumulation time frame to be checked step by step from the compelling date to the ending date, and the coupon time frame should be tallied starting from explicit coupon date onto the next. U.S. depository bonds generally use the Actual method technique.
In the actual/360 method, the actual no. of days from the effective date to the ending date is used for the accrual period, but the no. of days in the year is assumed to be 360. This is commonly used in money-market instruments.
The actual/365 and actual/365L are a portion of uncommon instances of the actual method. The actual/365 basis divides the actual no. of days by 365. The actual/365L considers leap years, giving a year basis of 366 for leap years and 365 for non-leap years.
- 30/360 method
Not quite the same as the actual/actual technique, there is no compelling reason to check the no. of actual days under this method. The 30/360 method decides the denominator of days in a year as 360, i.e. 12 30-day months. If the start day or end day of an accrual period falls on the 31st of a month. The date will be considered as 30th of that month. Corporate bonds usually have a 30/360 basis.
30/360 method further includes 30E/360, 30E+/360:
- Under the 30E/360 if the end of an accrual period falls in February, the real no. of days in February will be taken, rather than stretching the days to 30.
- Under the 30E+/360 if the first day of the accrual period falls on the 31st, it will still be moved to the 30th. But if the last day falls on the 31st then it will be moved to the 1st of the next month.
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Examples:
Assuming a Treasury bond and a Corporate bond both usually have the same annual coupon payment dates. Treasury bonds generally have an actual/actual basis, and corporate bonds have a 30/360 basis. Under the 30/360 basis, there are 90-days in the three-month accrual period, so the accrual factor for the corporate bond is 0.24 (90/360). The actual no. of days in the accrual period and the whole year should be tallied under the actual/actual basis. June has 30 days and both July and August have 31 days, so the accrual period contains 92 days.
Bottom Line:
We can say that the 30/360 days convention is easiest in its forms & allows simple calculations. On the contrary, the actual/actual convention gives value to each day in the accrual period.
Author – Priyanshu Ahuja
About the author – I’m a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and the investment domain.
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