What is Term
Depending on the context, the expression term can mean a couple of things in finance. It can refer to the lifespan assigned to an asset or a liability, over which the value of the asset/liability is expected to either grow or shrink, depending on its nature.
It can also refer to the period of time assigned to the lifespan of any investment. In the case of debt, it could refer to the time it takes for all payments to be made by the borrower and received by the lender. In the case of an equity investment, the time that elapses between the acquisition of the equity and its sale or removal from holdings for another reason.
A term can also specify a provision or nature of an agreement or contract, as in terms and conditions.
Understanding a Term
The life of an asset or investment generally falls into one of two main categories: short-term and long-term. An investment can be held for a very, very short period of time — for instance, a day trader might buy and sell a stock within seconds. On the other hand, the life of an investment can be as long as the life of a piece of land, which can span several generations and pass through the hands of many investors.
- Term can have multiple meanings based on context.
- It can refer to the time period of an investment, the provisions of an agreement or contract, and lifespan assigned to an asset or liability.
- The term (or maturity) of a product can play a significant role in assessing a security's riskiness.
Fixed income products generally add a third timeframe: intermediate. Short-term bonds are said to have a maturity, or term, of less than a year. Intermediate bonds will range anywhere from two to ten years in term. Lastly, long-term bonds have a maturity anywhere beyond 10 years.
When evaluating different securities, the term (or maturity) of a product can play a significant or insignificant role in assessing the security's riskiness. For example, the two and 10-year Treasury bond has no real premium for credit risk over time, as the U.S. is virtually default free between its short-term and long-term debts. However, for a bond rated junk, there's a big difference in credit risk between a bond maturing in two years and another maturing in 10 years.
Example of Term
Jay is a day trader. He buys a security on Monday and sells it on Tuesday. The term period of his holding for the security was one day. Jay also has life insurance which has a term period of 20 years, meaning it will mature in 20 years and Jay will get a payout from the insurance carrier. Finally, Jay lives in a rented apartment. According to the terms of his agreement with the landlord, he has to pay rent by the 5th of each month.