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.
- 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 five years, intermediate-term bonds of five to 12 years, and long term bonds of 12 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.