What Is Term to Maturity?
A bond's term to maturity is the length of time during which the owner will receive interest payments on the investment. When the bond reaches maturity the principal is repaid.
Key Takeaways
- A bond's term to maturity is the period during which its owner will receive interest payments on the investment.
- When the bond reaches maturity, the owner is repaid its par, or face, value.
- The term to maturity can change if the bond has a put or call option.
Bonds can be grouped into three broad categories depending on their terms to maturity: short-term bonds of one to three years, intermediate-term bonds of four to 10 years, and long-term bonds of 10 to 30 years.
Understanding Term to Maturity
Generally, the longer the term to maturity is, the higher the interest rate on the bond will be and the less volatile its price will be on the secondary bond market. Also, the further a bond is from its maturity date, the larger the difference between its purchase price and its redemption value, which is also referred to as its principal, par, or face value.
Interest Rate Risk
The interest rate on long-term bonds is higher to compensate for the interest rate risk the investor is taking on. The investor is locking in money for the long run, with the risk of missing out on a better return if interest rates go higher. The investor will be forced to forego the higher return or sell the bond at a loss in order to reinvest the money at a higher rate.
The term to maturity is one factor in the interest rate paid on a bond. The longer the term, the higher the return.
A short-term bond pays relatively less interest but the investor gains flexibility. The money will be repaid in a year or less and can be invested at a new, higher, rate of return.
In the secondary market, a bond's value is based on its remaining yield to maturity as well as its face, or par, value.
Why Term to Maturity Can Change
For many bonds, the term to maturity is fixed. However, the term to maturity can be changed if the bond has a call provision, a put provision, or a conversion provision:
- A call provision allows a company to pay off a bond before its term of maturity ends. A company might do this if interest rates decline, making it advantageous to pay off the old bonds and issue a new one at a lower rate of return.
- A put provision allows the owner to sell the bond back to the company at its face value. An investor might do this to recoup the money for another investment.
- A conversion provision allows the owner of a bond to convert it into shares of stock in the company.
An Example of Term to Maturity
The Walt Disney Company raised $7 billion by selling bonds in September 2019.
The company issued new bonds with six terms of maturity in short-term, medium-term, and long-term versions. The long-term version was a 30-year bond that pays 0.95% more than the comparable Treasury bonds.
FAQs
What Is Term to Maturity? A bond's term to maturity is the length of time during which the owner will receive interest payments on the investment. When the bond reaches maturity the principal is repaid.
What is an example of a bond maturity? ›
Trial and Error Example
An investor holds a bond whose par value is $100. The bond is priced at a discount of $95.92, matures in 30 months, and pays a semi-annual coupon of 5%. Therefore, the current yield of the bond is (5% coupon x $100 par value) / $95.92 market price = 5.21%.
What is the YTM explained? ›
YTM is yield to maturity which means the total return you expect from your investment in bonds/debt mutual funds if the same is held till maturity. It is expressed as a percentage of the current market price. It is used for comparing different bonds and debt funds with different maturities.
What is the yield to maturity for dummies? ›
–Yield to Maturity: This gives the annualized return investors earn if they buy a bond at its current market price and hold it until maturity, assuming the company makes all the required payments and the investor reinvests the interest payments at the same rate as the overall return.
What happens when I bond matures? ›
With a Series I savings bond, you wait to get all the money until you cash in the bond. Electronic I bonds: We pay automatically when the bond matures (if you haven't cashed it before then). Paper I bonds: You must submit the paper bond to cash it. See Cash in (redeem) an EE or I savings bond.
What happens when a bond is held to maturity? ›
Investors who hold a bond to maturity (when it becomes due) get back the face value or "par value" of the bond. But investors who sell a bond before it matures may get a far different amount. For example, if interest rates have risen since the bond was purchased, the bondholder may have to sell at a discount—below par.
How do you know when a bond matures? ›
U.S. Savings Bonds mature after 20 or 30 years, depending on the type of bond: Series EE bonds mature after 20 years. They are sold at half their face value and are worth their full value at maturity. Series I bonds are sold at face value and mature after 30 years.
How does maturity affect bonds? ›
Maturity Effect
Longer-term bonds experience greater percentage price change than shorter-term bonds for the same change in market discount rates. This heightened sensitivity is due to the higher number of periods (N) until maturity in the bond pricing equation for the longer-maturity bond.
What is defined maturity bond? ›
Defined-maturity bond funds hold a portfolio of bonds set to mature near the fund's expiration date. The bonds held by the fund can be replaced in the years leading up to the maturity date at the manager's discretion.
What is yield to maturity with an example? ›
Yield to Maturity Example
Suppose a company, ABC Ltd., issues 8% annual bonds of Rs 2,000. If you buy the bond when it is issued, you will be buying the bond at face value which will also be your purchase price. The bonds will pay the coupons at 8% or Rs 160 on August 17, 2021.
Bond yield = Annual coupon payment/ Bond price
For instance, a bond with a face value of ₹1,000 promises to pay 10% interest annually, and the current bond price is ₹1,200. The bondholder would receive an 8.33% yield at the current price.
How do you calculate YTM step by step? ›
Insert your values in the formula
For example, if you write your formula with a five percent coupon, it would look like this:YTM=[0.05 + (FV-PV)/n] / [(FV+PV)/2]The 0.05 value represents five percent coupon price and takes the place of the letter "C" in the formula.
What is the difference between yield and maturity? ›
A bond's current yield is the investment's annual income, the interest it pays, divided by the current price of the security. Yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until its maturation date.
Is it better to have a higher yield to maturity? ›
The higher the yield to maturity, the less susceptible a bond is to interest rate risk. There are other risks, besides interest rate risk, that can increase yield to maturity: the risk of default or the risk of a bond getting called before maturity.
What is another name for yield to maturity? ›
Yield to Maturity (YTM) – otherwise referred to as redemption or book yield – is the speculative rate of return or interest rate of a fixed-rate security, such as a bond.
What is the maturity value of a bond called? ›
Par value is essential for a bond because it defines its maturity value and the dollar value of coupon payments.
What is the difference between tenor and term to maturity? ›
Whereas tenor refers to the length of time remaining in a contract, maturity refers to the agreed-upon end date of the agreement upon its inception.
What is term to maturity or time to maturity? ›
Term to maturity refers to the remaining time until a bond reaches its maturity date. It represents the time frame the bondholder will receive the bond's face value or principal amount. The term maturity is typically expressed in years.
