Maturity

Definition

Maturity refers to the point in time when a financial instrument, such as a bond or loan, reaches the end of its term and the principal amount becomes due for repayment. It is a critical concept in the context of financial instruments, bond valuation, historical bond returns, and interest rate risk.

5 Must Know Facts For Your Next Test

1. Maturity date is the specific date when a bond or other financial instrument must be repaid in full, including the principal amount and any remaining interest payments.
2. Longer-term bonds generally have higher interest rate risk than shorter-term bonds due to the longer time until maturity.
3. The maturity of a bond is a key factor in determining its price and yield, as longer-term bonds typically offer higher yields to compensate for the increased risk.
4. Bond portfolios can be structured to match the maturity of the investor's liabilities, a strategy known as 'cash flow matching' or 'liability-driven investing'.
5. The historical returns of bonds are heavily influenced by changes in interest rates and the maturity of the bonds, with longer-term bonds generally experiencing greater price fluctuations.

Review Questions

• Explain how the maturity of a bond affects its price and yield.
  • The maturity of a bond is a key factor in determining its price and yield. Longer-term bonds generally have higher interest rate risk, as their cash flows are received over a longer period of time. This increased risk is typically compensated by higher yields to attract investors. Conversely, shorter-term bonds have lower interest rate risk and, therefore, tend to have lower yields. The relationship between a bond's maturity, price, and yield is inversely proportional, as investors demand higher returns for taking on the additional risk associated with longer-term bonds.
• Describe how the maturity of bonds can impact the historical returns of a bond portfolio.
  • The maturity of bonds in a portfolio can significantly impact the historical returns of that portfolio. Longer-term bonds are generally more sensitive to changes in interest rates, as their cash flows are received over a longer period of time. When interest rates rise, the prices of longer-term bonds tend to decline more sharply than shorter-term bonds, leading to greater price volatility and potentially lower returns. Conversely, when interest rates fall, longer-term bonds tend to experience larger price increases, resulting in higher returns. The historical picture of bond returns is heavily influenced by the maturity composition of the portfolio, with longer-term bonds exhibiting greater price fluctuations over time.
• Analyze how the maturity of a bond relates to its interest rate risk and the overall risk profile of a fixed-income portfolio.
  • The maturity of a bond is directly related to its interest rate risk, which is a crucial consideration in the context of fixed-income portfolio management. Longer-term bonds have a higher duration, meaning they are more sensitive to changes in interest rates. This increased interest rate risk results in greater price volatility for longer-term bonds compared to shorter-term bonds. Investors must carefully consider the maturity structure of their bond portfolio to manage the overall risk profile. A portfolio with a mix of short-, intermediate-, and long-term bonds can help diversify interest rate risk and provide a more stable return stream over time. By understanding the relationship between bond maturity and interest rate risk, investors can make informed decisions to align their fixed-income investments with their risk tolerance and investment objectives.

Related terms

Coupon Rate: The fixed interest rate that a bond issuer pays to the bond holder, typically paid semi-annually.

Yield to Maturity: The total return a bond will provide if held until its maturity date, taking into account the bond's current market price, coupon rate, and time to maturity.

Duration: A measure of a bond's sensitivity to changes in interest rates, calculated as the weighted average time until the bond's cash flows are received.