I'm totally new to the fixed income world.
My goal with this question is to gain an understanding how interest is accrued day-by-day for a particular instrument. This will obviously be done by an app in production, not by hand; This question is purely to increase my own knowledge on the topic.
I have access to a Bloomberg terminal if you'd like to point me to any helpful screens that I may have missed.
Consider this fixed income instrument:
3130A3GE8 Federal Home Loan Bank Maturity: 2024-12-13 Coupon: 2.75 % (CPN) Previous Coupon Date: 2019-06-13 Next Coupon Date: 2019-12-13
My goal is to figure out how much to accrue each day on this product. My original approach was:
(1)Determine the coupon frequency (CPN_FREQ). It's 2.
(2)Divide the coupon by the coupon frequency to obtain the interest rate for the current coupon period. In our case we end up with 1.375 % (2.75 / 2). This is confirmed by consulting the Bloomberg mnemonic ACCRUED_CALC_INT_RT.
(3) Determine the number of days in the period. There are 183 days in the period (2019-06-13 => 2019-12-13).
(4)Divide the coupon period's interest rate by the number of days in the period to obtain the daily accrual rate. This is 0.00751366% (1.375/183).
This process seems pretty straightforward. What I don't understand is where the "day count" (DAY_CNT) convention is used. The day count for this item is "30/360." But where does this come into play? I've Googled it and it appears that the day count is used when computing accrued interest, that is, the amount of interest that's added on to your clean purchase price (or sale price) when you make a trade.
So presumably if you submit a trade to me and provide me with a dirty price, I should use the day count method (which is well documented) to compute the amount of interest to subtract so as to obtain the clean price for use in computing the capital gain/loss portion of the trade. But that presents a problem. I don't understand how we could have two differing methods for calculating accrued interest, both of which I found online. What happens if the two methods generate different values? How does this affect the dirty=>clean price calculation? Presumably my confusion is due to context; i.e. both methods are correct but are used in different situations? Please enlighten me.