Held-to-Maturity Securities

What are Held to Maturity Securities?

 Held-to-Maturity (HTM) Securities are a type of financial asset that a company plans to keep until they reach maturity. These are usually bonds or other debt instruments with fixed payments and a set maturity date.

To be considered Held-to-Maturity Securites, a financial asset must have fixed or determinable payments, and the company must have both the capacity and intention to hold onto it until it matures. Assets categorized as fair value through profit or loss, available for sale, or loans and receivables are not included in the HTM classification.

If a business has sold or reclassified a significant amount of held-to-maturity investments prior to maturity during the current fiscal year or the two years prior, it is not permitted to categorize any financial assets as being held-to-maturity. It is assumed that such a company is unable to hold an investment until its maturity date. 

This restriction does not apply to reclassifications that occurred because of an isolated incident beyond the entity's control or that occurred so near to maturity or the asset's call date that changes in the market interest rate would not have significantly impacted the asset's fair value.

Since the holder of a held-to-maturity investment intends to keep ownership until the investment's maturity date, when the face value of the investment will be redeemed, there is no need to adjust the cost of the investment to fair value during the holding period.

Companies primarily employ held-to-maturity securities to diversify their investment portfolios, insulate themselves from interest rate volatility, and generate a modest, low-risk capital gain over a longer time frame. Debt instruments, like corporate or government bonds, typically make up most of these investments. 

How held-to-maturity security Works

The most popular type of HTM investments is bonds and other debt instruments, like certificates of deposit (CDs).

Bonds and other debt instruments are bought to be held until they mature and have predetermined (or fixed) payment schedules and fixed maturation dates. Stocks are not considered held-to-maturity securities since they lack a maturity date.

Corporations divide their investments in debt and equity assets into various groups for accounting purposes. The three classifications include:

1. "Held-for-trading" 
2. "Held-to-Maturity" (HTM)
3. "Available for sale"

These several categories are handled differently on a company's financial statements in terms of their investment value, as well as any associated gains and losses.

The accounting treatment for HTM securities follows these guidelines:

• Normally listed as non-current assets with an amortized cost. Amortization is an accounting technique that modifies the asset's cost gradually over time. 
• Interest income earned is reported on the company's income statement.
• Adjustments to the investment's market price are not reflected on the company's financial statements.
• HTM securities with a one-year or shorter maturity date are represented as current assets.
• HTM securities with maturities greater than one year away are classified as long-term assets and are recorded at amortized cost, which includes the original acquisition cost and all subsequent expenditures incurred up to that point.

Pros and Cons of Held-to-Maturity Securities

Purchasing held-to-maturity securities have advantages and disadvantages, just like any other investment. We'll talk about a few of those ups and downs in this section.

Some of the pros are:

• Holding securities until maturity typically entails very little risk. Returns are basically guaranteed as long as the bond issuer doesn't default.

• Since the returns on a bond are already predetermined at the time of purchase (i.e., coupon payments, face value, and maturity date), they are not sensitive to news or industry trends. As a result, even if the market value changes, the bond's holder will keep it until it matures, guaranteeing the same return.

• Bonds are lower-beta assets that allow investors to diversify the risk in their portfolios and plan for long-term goals.

• The returns on held-to-maturity securities are predetermined and locked in at the time of purchase, making them relatively predictable, as market changes have no effect on their value.

• These investments assist investors in creating long-term financial plans because the buyer has validated the specifics of the timing of the returns and the amount of return they will receive by/upon maturity.

The cons are:

• Held-to-maturity securities impact a company's liquidity. Companies cannot actually rely on these assets to be sold if cash is needed in the short term because they commit to holding these securities until maturity.

• Since the returns on these securities are predetermined, as was already mentioned, there is limited upside potential, with considerable downside protection. The company's returns on bonds, for example, won't increase if financial markets rise overall.

• Despite being small, the risk of default must, nevertheless, be taken into account.

• Holding these securities until maturity is their intended purpose; they are not supposed to be short-term, liquid investments.

Held-to-Maturity Securities Example

Management plans to trade or sell debt and equity securities in the future as "trading" and "available-for-sale" securities. On the other hand, held-to-maturity securities are exclusively debt securities. 

This is due to the lack of a maturity date on equity securities. Stocks don't grow old. Bonds and other debt securities will reach their maturity date at some point in the future. A debt security that management plans to keep until it matures is known as held-to-maturity security. 

In other words, a bond would be categorized as held-to-maturity security if a corporation purchases a 10-year bond and management plan to hold it for 10 years.

If securities are held-to-maturity for more than a year, they are recorded as long-term assets at amortized cost. Securities held-to-maturity are represented as current assets if the maturity date is in the next year or less.

Simply put, all securities are seen as investments. Based on what management intends to do with the capital, accountants distinguish between different types of investments. 

Keep in mind that management cannot simply intend to act in the way the categorization implies. They must be able to carry out their intentions. In other words, for management to be able to describe its equities as trading, it must actually have a market and the ability to sell them.

Conclusion

Securities that are held-to-maturity are included in the group of all marketable securities. Every category of security contributes to the company's performance in some way.

Held-to-maturity securities can help a business stabilize its equity portfolio with safer, longer-term investments or hedge against inflation.

With the exception of big equity portfolios, like Berkshire Hathaway and Markel, held-to-maturity securities normally account for a larger share of the investment portfolios of most firms, whereas equity positions make up a smaller portion.

This accounting standard can be used by a corporation for its long-term investments, preventing market volatility and allowing it to forecast fixed returns from a portion of its portfolio.

The accounting classification of investments affects the profits a firm makes on its assets; thus, as an investor, the concept is important to grasp. However, it also restricts a company's ability to raise money, and if management is not proactive, it may lock up money at a reduced rate of return. 

Researched and authored by Rishav Toshniwal | LinkedIn

Reviewed and edited by Justin Prager-Shulga | LinkedIn

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