Day Count Conventions

Interest accrues continuously between coupon payments, but "how many days between two dates" is not as obvious a question as it sounds once you need to compare instruments across markets. Some conventions treat every month as having exactly 30 days regardless of the calendar; others count the actual number of calendar days; some divide by an assumed 360-day year, others by the true 365 (or 366). A day count convention is simply the fixed rule a bond, loan, or swap contract specifies upfront for doing this counting, written as a ratio like "30/360" or "Actual/365."

The reason this matters is that the same stated annual rate, applied to the same two dates, produces a slightly different dollar amount of accrued interest depending on which convention is in force — so day count conventions have to be specified explicitly in every contract and matched carefully when comparing yields across instruments that use different ones.

A worked example

A bond paying 6% annual interest, using 30/360 counting, treats a period from January 1 to March 1 as exactly 60 days (two 30-day months) and calculates accrued interest as $6\% \times 60/360 = 1\%$ of face value. The same bond under Actual/365 counting would use the true 59 calendar days between those dates, giving $6\% \times 59/365 \approx 0.97\%$ — a small but real difference that matters when settling a trade or comparing yields quoted under different conventions.