Day-Count Convention
Candlefocus EditorThe most common day-count conventions used in securities and financial markets are 30/360, 30/365, and actual/360. The 30/360 day-count convention is based on the assumption that there are 30 days in a month and 360 days in a year. It is the most commonly used day-count convention for fixed-rate securities, especially corporate bonds. Under this convention, each month is assumed to be 30 days and the number of days in a year is always assumed to be 360. As such, the total amount of interest earned is calculated by dividing the length of the contract by 360.
The 30/365 day-count convention assumes there are 30 days in a month and 365 days in a year. It is commonly used for mortgage-backed securities, including those involving U. S. government-sponsored entities such as Fannie Mae and Freddie Mac. While it is conceptually simpler than 30/360, it provides slightly different interest calculations. For example, under the 30/365 convention, the number of days in February of a leap year is calculated to be 30, while under the 30/360 convention, it would be assumed to be 28.
The actual/360 day-count convention assumes that the actual number of days between two given dates is divided by 360. This convention is commonly used for calculating the interest rate on floating-rate notes and money market deposits. It tends to be more accurate than either the 30/365 or 30/360 method and it also allows for more flexibility in determining the exact number of days between two given dates.
Overall, day-count conventions are crucial for calculating the correct level of interest earned on financial securities and for pricing for derivatives. They provide financial markets with the consistency required to accurately calculate and accurately track the amount of interest earned on financial instruments. Knowing the differences among the different day-count conventions and properly calculating interest are both essential to a successful financial market.