Day-Count Convention
What it is:
A day-count convention is a method of counting the days between coupon dates.
How it works/Example:
Let's assume a $1,000 bond from Company XYZ has a 10% coupon, which means it pays out $100 a year. The bondholders get the $100 in two installments; that is, they get paid every six months.
It may sound simple to say, "six months from now, we'll send you a check," but what day is "six months from now"? Let's assume today is January 1. Various dates equate to "six months from now":
- If you simply choose the sixth month of the year, you get June 1.
- If you divide 365 days by two and add the result to January 1, you get July 2.
- If you assume there are 30 days in a month (times six months), you get May 31.
None of these consider that it might be a leap year, either.
As you can see, the method for calculating "six months from now" needs defining. For this reason, bond issuers set forth day-count conventions.
Why it matters:
The most common kind of day-count convention is the 30/360 convention, which assumes that there are 30 days in each month and therefore just 360 days in a year. However, conventions vary by instrument, and it's important to understand how interest is calculated before investing. Day-count conventions also determine how loan interest, swaps and other debt-based vehicles work. In turn, they influence the calculations of returns from those investments.