Day Count Conventions

Day count calculations describe the different methods of evaluating the fraction of a year between two dates. This fraction is often referred to as the day count fraction.

Day count fractions are fundamental to working out the payments of bonds and many derivatives, because they are used to calculate the amount of interest that should be accrues between two dates.

So, for example, let's say that you own $10,000 of a 10 year bond which pays 10% quarter annually (four times a year) starting from January 1 2006. 10% is the annual rate, and the bond will pay a portion of this annual rate every quarter, the accrual periods are:

2006/1/1 to 2006/4/1 $10,000 x 10% x day count fraction
2006/4/1 to 2006/7/1 $10,000 x 10% x day count fraction
2006/7/1 to 2006/10/1 $10,000 x 10% x day count fraction
2006/10/1 to 2007/1/1 $10,000 x 10% x day count fraction
etc...

The day count fraction will, in most instances, differ from accrual period to accrual period.

There are many different ways of calculating the fraction of year between two dates which cover many different methods for resolving both the number of days between the dates, as well as the number of days in the year.