Interest Rate Vasis

Definition of Interest Rate Basis

In finance Interest rate basis which also depicted as Day count convention, is designated to regulate the amount of accumulated interest over the time period on a distinct type of investment like notes, bonds, mortgages, loans, medium term notes, swaps, and forward rate agreements (FRAs). This method is used to calculate the number of days between two coupon payments by calculating the amount made transaction on the payment dates and also the accumulated interest rate for dates between the payments.

• When a person sells a security like bond between the dates of payments, the seller gains some fraction of the coupon amount. It is seen that each bond market possess its own Day count convention.

• There are several different types of Day count conventions which are used in the financial market. The motive of different conventions is to pinpoint the conflicting requirements of including the constancy of the time period (day, month, or year), the needs of the Accounting department and ease of calculation.

Books on Interest Rate Basis

Book 1:

Interest-rate Swaps By Brian Coyle (published by Global Professional Publishi, 2001)

Book 2:

Introduction to Fixed Income Analytics: Relative Value Analysis, Risk Measures and Valuation By Frank J. Fabozzi, Steven V. Mann (published by John Wiley & Sons, 2010)

How Interest Rate Basis/ Day count convention works?

Here are two of examples that convey the notions of Day count convention, are discussed below,

• Let’s say, a 30/360 day-count convention is taken in order to determine the accumulating interest and present value assumes that there are 360 days in the year and 30 days in a month. This assumption may be impractical when comes down to a realistic situation. After all in every bond market, there is a stander of 365 days in the year.

• In actual/actual day-count convention, the assumption is taken as the actual number of days in month and actual number of days in a year to determine interest rate in between the given time.

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