An essential aspect to understand about bonds is their maturity period. The bond’s maturity period can influence its yield, price volatility, and role in an investment portfolio. Let’s discuss bond maturity periods and their significance for investors.
Bond maturity refers to the date when the bond’s principal amount (or face value) is scheduled to be repaid to the bondholder. Till the maturity date, the issuer pays periodic interest, known as the coupon, to the bondholder. At maturity, the issuer repays the principal amount in full.
The general guideline used to classify bonds by their maturity period is as follows:
- Short-term bonds: Maturities of less than 5 years.
- Intermediate-term bonds: Maturities ranging from 5 to 10 years.
- Long-term bonds: Maturities of more than 10 years, with some bonds having maturities extending to 30 years or more.
Significance of maturity period to bonds
- Interest rate sensitivity: The bond’s maturity period directly impacts its sensitivity to interest rate changes. Longer-term bonds are generally more sensitive to interest rate changes than short-term bonds. When interest rates rise, long-term bond prices tend to drop more significantly than short-term bonds, and vice versa.
So, in a rising interest rate environment, shorter-term bonds might be more favourable than long-term bonds, while in a declining interest rate scenario, locking in a higher yield with long-term bonds could be beneficial. - Yield: Typically, longer-term bonds offer higher yields to compensate for the potential risks associated with a more extended period.
- Liquidity: Short-term bonds, especially those nearing maturity, often have higher liquidity than longer-term bonds. That said, Treasury bonds almost always have high liquidity, irrespective of their maturity period.
- Risk tolerance: Longer-term bonds expose investors to more interest rate risk. So, those with a low risk tolerance can have more exposure to short-term bonds than those with a high risk tolerance.
- Market conditions: In a rising interest rate environment, shorter-term bonds might be more favourable, while in a declining rate scenario, locking in a higher yield with long-term bonds could be beneficial.
Short-term bonds
Some of the characteristics of short-term bonds are as follows.
- Risk and return profile: Typically have lower interest rate risk, meaning their prices are less sensitive to changes in interest rates. Consequently, they usually offer lower yields compared to longer-term bonds due to their lower risk.
- Suitability: Investors looking for liquidity and less exposure to interest rate fluctuations may prefer short-term bonds.
- Examples: Treasury bills and short-term corporate bonds.
Intermediate-term bonds
Some of the characteristics of intermediate-term bonds are as follows.
- Risk and return profile: These bonds carry a moderate level of interest rate risk and generally offer higher yields compared to short-term bonds to compensate for the additional risk.
- Suitability: They can be suitable for investors seeking a balance between yield and interest rate risk.
- Examples: Medium-term Treasury notes and intermediate-term corporate bonds.
Long-term bonds
Some of the characteristics of long-term bonds are as follows.
- Risk and return profile: Long-term bonds are more sensitive to interest rate changes, making them more volatile in price compared to short-term and intermediate-term bonds. They usually offer higher yields to compensate for the increased risk and price volatility.
- Suitability: Investors looking for higher income and those who can tolerate price fluctuations might consider long-term bonds.
- Examples: Long-term Treasury bonds and long-term corporate bonds.
Conclusion
Understanding the classification of bonds by maturity period is crucial in constructing a bond portfolio that aligns with one’s investment goals and risk tolerance. Each bond type offers a distinct risk and return profile, catering to different investor needs and preferences. The overall economic outlook, interest rate predictions, and individual investment goals are all pivotal considerations when selecting bonds across different maturity periods.
Related information
Refer to the related knowledge resources:
- An introduction to Total Return Bond ETF
- An introduction to bond ratings
- Impact of rising interest rates on a bond ETF
- An introduction to risk-free bonds and risk-free rate
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