What is term to maturity?
The term to maturity of a bond is the length of time the owner will receive interest payments on the investment. When the bond matures, the principal is repaid.
Key points to remember
- The term to maturity of a bond is the period during which its owner will receive interest payments on the investment.
- When the bond matures, the owner is repaid its face value.
- The term to maturity may change if the bond has a put or call option.
Bonds can be grouped into three broad categories based on their term to maturity: short term one- to three-year bonds, four- to 10-year mid-term bonds, and long term bonds of 10 to 30 years.
Understanding Term to Maturity
Generally, the longer the term to maturity, the higher the bond’s interest rate will be and the less volatile its price will be in the secondary bond market. Also, the further a bond is from its maturity date, the greater the difference between its purchase price and its redemption value, also known as principal, face or nominal value.
Interest rate risk
The interest rate of long-term bonds is higher to compensate for the interest rate risk that the investor assumes. The investor is tying up money for the long term, with the risk of missing out on a better return if interest rates rise. The investor will be forced to forgo the higher yield 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 duration, the higher the yield.
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, the value of a bond is based on its remaining yield to maturity as well as its face or face value.
Why the term to maturity may change
For many bonds, the term to maturity is fixed. However, the term to maturity may be changed if the bond includes a prepayment clause, a to provideor a conversion clause:
- A call clause allows a company to redeem a bond before the end of its maturity. A company could do this if interest rates fall, making it advantageous to pay off old bonds and issue a new one at a lower rate of return.
- A sell provision allows the owner to sell the bond back to the company at face value. An investor might do this to recover money from another investment.
- A conversion clause allows the owner of a bond to convert it into shares of 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 maturities in short, medium and long-term versions. The long-term version was a 30-year bond that yields 0.95% more than comparable Treasuries.