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.
Term to maturity is the remaining life of a bond or other type of debt instrument. The duration
duration
Macaulay duration is the weighted average of the time to receive the cash flows from a bond. It is measured in units of years. Macaulay duration tells the weighted average time that a bond needs to be held so that the total present value of the cash flows received is equal to the current market price paid for the bond.
ranges between the time when the bond is issued until its maturity date when the issuer is required to redeem the bond and pay the face value of the bond to the bondholder.
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.
For example, a 30-year mortgage has a maturity date three decades from the date it was issued and a 2-year bond has its maturity date twenty-four months from when it was first issued. The maturity date also maps out the period through which the investors will receive interest payments.
A YTM example can be an investor buying a bond whose par value is $100. The bond is currently priced at a discount of $95, matures in 12 months, and pays a semi-annual coupon of 5%. Therefore, the current yield of the bond is (5% coupon x $100 par value) / $95 market price.
The yield to maturity (YTM) is an estimated rate of return. It assumes that the bond buyer will hold it until its maturity date and reinvest each interest payment at the same interest rate. Thus, yield to maturity includes the coupon rate within its calculation. YTM is also known as the redemption yield.
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.
Macaulay duration calculates the weighted average time before a bondholder receives the bond's cash flows. As a bond's maturity increases, duration increases, and as a bond's coupon and interest rate increases, its duration decreases.
Investors who plan on holding their bond until maturity typically don't need to worry about the movement of bond prices on the secondary market as they will be repaid their principal in full at maturity, barring a default.
Generally, a bond that matures in one to three years is referred to as a short-term bond. Medium- or intermediate-term bonds are generally those that mature in four to 10 years, and long-term bonds are those with maturities greater than 10 years. Not all bonds reach maturity.
As an example, let's assume a company issues a million dollars worth of bonds in January 2020, all of which are set to mature on the same date two years later. The investor can expect to receive repayment from these term bonds in January 2022.
Key Takeaways. Yield to maturity is the total rate of return earned when a bond makes all interest payments and repays the original principal. YTM is essentially a bond's internal rate of return if held to maturity.
Helps in Making Investment Decisions: YTM is an essential tool for investors as it helps them make informed investment decisions. For example, if the YTM of a bond is lower than the expected rate of inflation, the bond may not be a good investment because the real return on investment may be negative.
As these payment amounts are fixed, you would want to buy the bond at a lower price to increase your earnings, which means a higher YTM. On the other hand, if you buy the bond at a higher price, you will earn less - a lower YTM.
You can achieve this by multiplying the bond's years to maturity by the number of coupon payments per year. If the bond pays an annual coupon rate, divide the annual coupon rate by two to determine the semi-annual rate for easier calculations.
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.
The prices of bonds with a longer term to maturity are more sensitive to changes in interest rates. Prices of bonds with longer maturities will decline by a larger magnitude as compared to bonds with shorter maturities when interest rates rise.
A bond is said to mature on the date when the issuer repays its notional value. zero−coupon bonds compensated for making such an investment? Such bonds are purchased at a discount, below their face value. A bond will trade at a discount if its coupon rate is less than its yield to maturity.
Callable or redeemable bonds are bonds that can be redeemed or paid off by the issuer prior to the bonds' maturity date. When an issuer calls its bonds, it pays investors the call price (usually the face value of the bonds) together with accrued interest to date and, at that point, stops making interest payments.
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