Maturity in finance refers to the lifespan of a financial instrument. The maturity date is the day when the payment becomes due for a debt instrument.
Definition and Example of Maturity and Maturity Value
When the maturity date arrives and the principal and interest are paid, it marks the end of the legal agreement. The maturity value is the total amount that the investor will receive at the end of the lifespan of the debt instrument. It can be expressed as follows:
MV = Principal + (Principal × Interest Rate × Years to Maturity)
For example, if a company issues a bond with a face value of $10,000 that pays an annual coupon of 3% and matures in five years, the bondholder will receive $300 annually, or $1,500 over the life of the bond. The principal amount of $10,000 will be repaid at the end of the five years.
Maturity Value = $10,000 + ($10,000 × 0.03 × 5) or $11,500
The maturity value of the bond is $11,500. The original principal amount of $10,000 is known as the par value.
Types of Maturity
Maturity generally refers to the due date of a financial agreement. Here are some examples of when financial maturity applies:
Deposit Maturity
The investor deposits a certain amount of money (a minimum amount may be specified) with the agreement to leave it deposited for a specified period of time. The agreement specifies how much interest will be paid and how often. The principal repayment date is the maturity date. A common example is a Certificate of Deposit. Generally, the longer the investment period, the higher the interest rate. There may be a penalty for withdrawing funds before the maturity date.
Bond Maturity
This represents the remaining time in the life of the bond. The due date for principal repayment, along with any interest payments due.
Not all bonds are held until maturity. Callable bonds allow the issuer to redeem the bond before the maturity date. The issuer pays the par value and any interest accrued until that date. Sometimes a call premium is also paid.
Structured Note Maturity
Structured notes are securities issued by financial institutions that have a fixed maturity and derive their value from one or more underlying assets, with the return linked to the performance of those assets. Structured notes are typically illiquid, so investors should expect to hold them until maturity.
Why Does Maturity Matter to Investors?
It is important for investors to ensure that any investment vehicle features a maturity date that aligns with their investment timeline. A short-maturity investment may not be suitable for an investor seeking long-term growth. Generally, short-maturity fixed-income investments yield lower returns.
On the other hand, it would be unwise to lock up money in an investment with a distant maturity date if there is a chance of needing the capital before maturity, as penalties may be incurred for early withdrawal.
Key Takeaways
Maturity is the end date of a financial agreement, leading to the payment of principal with interest or the repayment of a loan with interest. Maturity typically applies to fixed-income investments like bonds or certificates of deposit, as well as loans. If an individual invests in a security with a maturity date and withdraws the principal before that date, a penalty may be applied. Borrowers can typically repay the loan before maturity without penalty and save on interest expenses by doing so. The maturity value of the loan is the total cost of the loan, including the principal and interest paid over the life of the loan.
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Sources:
U.S. Securities and Exchange Commission. “Callable or Redeemable Bonds.” Accessed Oct. 13, 2021.
U.S.
Securities and Exchange Commission. “Investor Bulletin: Structured Notes.” Accessed Oct. 13, 2021.
Source: https://www.thebalancemoney.com/what-is-maturity-in-finance-5205486
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