Term to Maturity
It is the years left for a bond to mature.
What is Term to Maturity?
Term to maturity (TTM) is the years left for a bond to mature. When a bond matures, it means that the bondholder (the person who owns the bond) gets paid back the face value of that bond, which usually amounts to $1,000.
Throughout the bond's life, the bondholder lends money to the bond sellers (governments, corporations, municipalities, etc.). During that period, the bond buyer receives periodic payments called coupon payments.
At the end of the loan, the bond is said to be matured, and the investor gets paid back the face value of the bond. The face value of a bond is what the borrower repays at the end of the bond's maturity. It usually equals $1,000, or a tenth multiple of it.
Different debt investors aim to buy bonds with distinct aspects. One of these aspects that are often focused on is the term maturity. Some investors would like to buy bonds with shorter times to maturities, while others prefer those with longer times to maturities.
Bonds with shorter time to maturities are called short-term bonds. These types of bonds typically have a maturity of one to three years. The most common type of short-term bond is treasury bills or T-bills. They usually mature in a year or less.
Bonds can also be classified as intermediate-term bonds. They have a term to maturity of three to ten years. An example of such bonds is the VBIIX fund (Vanguard Intermediate-Term Bond Index Fund Investor Shares). It is a mutual fund that includes numerous intermediate bonds term.
Lastly, some bonds have a much longer life. Bonds that mature in more than ten years are known as long-term bonds. These bonds include long-term government bonds (up to 30 years) and other corporate bonds.
As a rule of thumb, the longer it will take for the bond to mature, the higher the interest rate will be for that bond. Ceteris paribus, Long term bonds typically have higher interest rates than other bonds with shorter time to maturity.
Key Takeaways
- The term maturity of a bond is the number of years left for a bond to mature.
- The bondholder gets paid back the principal amount or the bond's par value whenever a bond matures.
- Bonds can be classified according to their TTMs into short-term, intermediate-term, and long-term bonds.
- Every bond quoted in the market has its term to maturity listed in the quote as the first item.
- Although bonds are expected to have a fixed term to maturities, they can be subject to change due to call provisions and put provisions.
- Call provisions give the bond issuers the right to redeem or "call" back the bonds before they mature.
- Put provisions give the bondholders the right to sell the bond back to the bond issuer.
- Interest rate risk is the risk bondholders face because of varying interest rates in the market.
- Generally, the larger the time to maturity of the bond, the greater degree to which interest rate risk is present.
- Compared to a short-term bond, long-term bonds' price (value) is much more sensitive to interest rate changes.
Term to Maturity and bonds
The most common way for corporations and governments to borrow money from the public over the long term is by issuing bonds. Bonds are debt securities sold to the general public in exchange for funds.
Bonds are usually a type of interest-only loan. This means that the principal, the amount borrowed initially, will be repaid by the issuer once the bond's maturity. The issuer will only make periodic interest payments.
For example, suppose a tech company borrows $1,000 from you in the form of a bond for 25 years. The interest paid on such securities from tech companies is roughly 11 percent annually. This means that the company will pay you $110 annually as interest.
Only at the end of the 15 years, when the bond matures, is when you get paid back the principal of $1,000. This is the typical arrangement for most bonds. As a result, many investors buy bonds as a safe investment because some types of bonds offer shallow risk with foreseeable returns.
However, there is a multitude of terms that we should be familiar with surrounding bonds. The jargon used in the debt market may be overwhelming, but each term has a simple and specific meaning.
Factors related to Bonds
There is a particular vocabulary for everyone to know to understand bonds. These terms describe the essential characteristics of bonds, like the amount to be paid back when the bond matures, coupon rate, etc. The previous example is going to be used to introduce these terms.
1. Maturity
The time to maturity of a bond is the number of years until the par value of the bond is paid. For example, when a corporate bond is initially issued, its maturity is usually 30 years. As time progresses after the bond has been issued, fewer years remain until it matures.
In our previous example, the bond's term to maturity was 25 years. This means you will get interested every year for 25 years. At the end of the 25 years, you will get paid back the initial amount you lent, which was $1,000.
2. Face value (par value)
A bond's face value - also referred to as par value - is the sum of money that the lender gets repaid when the bond matures. In our example, the glue had a face value of $1,000. That is because, at the end of the 25 years, the amount to be repaid equals $1,000.
Like in our example, corporate bonds usually have a face value of $1,000. If such a bond is sold for $1,000, it is known as a par value bond. However, other bonds, like government bonds, typically have large par values.
3. Coupons and the coupon rate
In finance, coupons are the annual (or semiannual) interest payments made to the lender. In the previous example, $110 paid to you every year is the coupon payment that the bond provides you with. Bonds that have equal periodic coupon payments are known as level coupon bonds.
Bonds that offer no coupon bonds are known as zero-coupon bonds. The most prominent zero-coupon bonds are US savings bonds and US treasury bills. Bonds are sometimes called bills whenever the maturity of the bonds is less than one year.
The coupon rate is the size of coupons received annually divided by the face value of the bond. In the above example, the annual coupon received equals $110. Therefore, the coupon rate equals $110 / $1,000 = 11% = 0.11.
The yield to maturity is crucial in calculating a bond's price or present value. Yield to maturity is the interest rate other bonds with similar and identical structures earn.
In our example, the YTM was mentioned to be 11%. In this case, the yield to maturity is equal to the coupon rate, but this is only sometimes the case. YTM will only be similar to the coupon rate if the bond is sold at par value. YTM will be greater than the coupon rate if it is a discount bond.
bond's term to maturity
As mentioned, the term maturity of a bond represents the years left for a bond to mature. At the end of a bond's useful life, the bond is said to grow. At the end of maturity, the investor gets paid back what is known as the bond's principal or face value.
During the bond's life, bondholders get periodic interest payments called coupon payments. These payments typically occur semiannually or once every six months and are not paid at the end of the bond's life at maturity.
Suppose a bond is not paid its interest payments; however, in that case, the bondholder must get paid back the principal value of the bond (usually $1,000) in addition to all the coupon payments that have been accumulated since the date of issuance at the end of its maturity.
Every bond quoted in the market has its term to maturity listed in the quote. Usually, the TTM of a bond is listed as the first item, followed by the coupon rate, the bid and ask prices, and finally, the change of the asking price compared to the previous day.
Since the term to maturity is quoted in the market, then it is expected for all bonds to have fixed TTMs. However, this may only sometimes be the case. Some bonds have an aspect which is called "call provisions."
Call provisions are one of the agreements listed in a bond's indenture. For corporate bonds, for instance, call provisions give the corporation the right to redeem or "call" back the bonds before they mature. Typically, the company pays a predetermined price to repurchase the bonds.
The repurchase of the bonds by the issuer is one of the cases in which the bond's maturity can change because called bonds mature the moment they are redeemed.
The bondholder also can have the right (but not the obligation) to sell the bond back to the bond issuer. This is called a put provision, and it represents another case in which the bond's time to maturity can change.
Time to maturity and interest rate risk
Interest rate risk is the risk bondholders face because of varying interest rates in the market. Bond prices have an inverse relationship with interest rates. That is to say, when interest rates rise in the market, bond prices tend to fall.
Why will bond prices fall following an increase in the interest rate? However, before answering that question, it is crucial to state an essential point about the price or value of bonds.
The current value of a bond is contained in its principal or face value and the coupon payments it receives. Therefore, if the interest rates in the markets rise, newer issued bonds should earn larger coupon payments.
This means that the new bonds become more attractive than the bonds that the bondholders currently have in their hands because of the higher interest payments they receive.
Hence, whenever the bondholder wants to sell the bond in the secondary market, they must do so at a lower price because of the low demand for those bonds. This is also known as selling bonds at a discount. This is what is meant by interest rate risk.
What does the time to maturity of the bond have to do with the interest of a bond? The interest risk depends on two main factors:
- The coupon rate of the bond: in general, the lower the bond's coupon rate, the greater the degree to which interest rate risk is present.
- The time to maturity: in general, the larger the time to maturity of the bond, the greater degree to which interest rate risk is present.
Compared to a short-term bond, the price of long-term bonds is much more sensitive to interest rate changes. Take, for example, two bonds with a coupon rate equal to 10%. The first bond matures in one year, while the second matures in thirty years.
With an interest rate of 10% in the market, both bonds' current values will equal the face or par values of $1,000. Suppose the interest rate in the market increases to 15%:
- The value of the bond with a term to maturity of one year will decrease to $956.52,
- The value of the bond with a term to maturity of thirty years will fall to $671.70.
We can see the drastic difference in the prices of two bonds of different TTMs (other things held constant) whenever the interest rate increases. Now suppose the interest rate in the market decreases to 5%:
- The value of the bond with a term to maturity of one year will fall to $1,047.62,
- The value of the bond with a term to maturity of thirty years will drop to $1,768.62.
In this case, the long-term bond is the one that benefits from the interest rate decrease. However, it's more prominent for the economy (especially nowadays) to experience interest rate increases, like the interest rate hikes by the Fed.
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