Day-Count Convention
AdvancedA day-count convention is the rule used to calculate how much interest accrues between two dates, by defining how the days in the period and in the year are counted.
Interest is usually quoted as an annual rate, but payments cover periods that are not exactly one year. The day-count convention decides how to convert the annual rate into interest for the actual period.
Common conventions include actual/360, which counts the actual days and assumes a 360-day year, widely used in money markets; actual/365, which assumes a 365-day year; actual/actual, often used for government bonds; and 30/360, which treats every month as 30 days, common for some corporate bonds.
For example, interest at 5% on 1,000,000 for 90 days is 12,500 under actual/360, but about 12,329 under actual/365. The difference may seem small, but it matters for large transactions.
Day-count conventions vary by market, currency and type of instrument, and are specified in the terms of each bond, loan or derivative. Using the wrong convention leads to incorrect interest calculations and pricing errors.
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