How does bond maturity work?

8 months ago forexsimulation 0

The term of a bond is the length of time until the principal and interest must be repaid. Bonds usually have terms of 10, 20, 30, or 40 years. To find out a bond’s duration, you can do a google search on “bond name” maturity date. Most bonds are issued with a specific maturity date, which means that all payments will be made on that date. For example, if you buy a new issue from General Electric, it will say that the issuer plans to repay 100% of face value in five years (the terms may range from x-year to y-year, but it all adds up to five).

But sometimes, companies extend their maturities or make them more complex by adding provisions such as call or sinking funds. A call feature allows the issuer to retire part or all of the issue before maturity. The company will call (buy back) the bonds from investors at a set price, usually higher than the face value. Bonds may also have a sinking fund, a reserve account funded by payments made by the issuer over the life of the bond. This account is used to retire debt before the maturity date.

Investor protection

Both features are intended to protect investors from holding a bond until it matures. If interest rates fall after a bond is issued, the issuer may call and retire it, forcing investors to reinvest their money at a lower rate. Or, if interest rates rise, the issuer might have to pay a higher interest rate on the bonds it issues to replace those due to maturity, increasing its borrowing costs.

Bond extension

A bond’s maturity can also be extended in other ways under certain circumstances. For example, an issuer may have the option to extend payment periods or defer principal repayments when there’s been a change in tax laws or when there have been either “acts of God” or an act of war. Bondholders can usually sue for damages if these types of events occur. Some bonds include options called put features, which allow investors to sell their bonds back at par value anytime after they’ve been issued. All these changes will typically be reflected in the new issue prospectus.

Main reasons to own a bond until it matures

1) You’re expecting to receive all of the interest payments and principal back at maturity

2) You think interest rates are going to go up, so you want to lock in today’s rates by holding the bond until it matures.

Call features/sinking funds

You don’t need to worry about call features or sinking funds if you’re in the first group. But if you’re in the second group, you should keep an eye on whether the issuer has a put feature. If it does, that means that you can sell your bond back to the issuer at par value any time before maturity. It gives you some protection against rising interest rates. However, if interest rates fall, you may want to consider selling the bond in the open market. If rates rise, the issuer may call the bond, and you won’t sell it in the secondary market.

Prospectus

When considering a new issue of bonds, check the prospectus and find out what kind of terms and provisions they have. These can affect how you plan to use your new investment. You should also keep an eye on your holdings throughout the period, so you aren’t surprised when they come due or if there is a put feature that allows you to sell them back at par value before maturity.