Bond Maturity
The bond maturity is the date stated in the contract on which an issuer will repay the principal to a lender. Maturity is the final phase of a bond and the only component that cannot change. If an investor purchases a 10-year Treasury bond issued in 2020 and the maturity date is scheduled for delivery by the year 2030, then regardless of how interest rates fluctuate throughout that period, when all is said and done — as part of their fulfilling obligation to exchange payment at par value with this same bondholder via previously recorded IOU documentation for purposes such as continuing; government expenditures.
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Fixed Nature: A bond’s maturity date is established at issuance through a contract and does not fluctuate with the market or unexpected events. Even in case of a steep drop or rise in the market interest rates, the issuer is obliged to pay back the principal at maturity. One example might be a 30-year U.S. Treasury bond issued in the year 2020, which is set to mature at some point in 2050.
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Investor Focus: Investors normally select the holding period in reference to when the bond matures. The risk of interest rate in the holder increases as far as their maturity date. The same goes for a 2-year corporate bond than for a ten-year Treasury since the former is less exposed to changes in interest rates. At 5% U.S. two-year Treasury yields, and rates at this very recent moment of writing around those levels out to the Dec./21 end date for available fed funds rate futures trading with new prospects ahead still more consistent also more reflective then than now, market pricing of all other interest-rate risk as well dates a decade further.
Bond Duration
The bond duration, a measure of a bond’s price sensitivity to interest rate changes, is a concept that enlightens investors. It’s not the same as its maturity, but it measures it using present values of each cash flow (coupon payments, principal repayments etc.) weighted by their receipt in a bond formula. Duration shows us how long (on average) it would take for an investor to get their principal returned, shedding light on the bond’s behavior in response to interest rate changes.
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Interest Rate Risk Tool: Understanding bond duration is crucial as it determines the bond price’s sensitivity to interest rate changes. The rule of thumb is that for every percent increase in rates, for each additional year away your bond duration gets from maturity, there should be a proportional decrease to the price move by about 1%. In simple terms, if a bond has a 7-year duration and interest rates rise by 1%, its price could fall about 7%. A bond with a 3-year duration would only have a price drop of perhaps 3% while this hypothetical one percent is raising the interest rate. This understanding is key, as it shows that 7-year duration U.S. Treasury bonds were approximately twice as volatile in price as an equivalent investment in the 3-year space, demonstrating the importance of a specific target with respect to sensitivity, which most end investors may not understand or anticipate, yet ought to be at least partially aware of by now given what is being lined up into.
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Present Value-Weighted Calculation: Duration is not just a function of the bond’s maturity but also contemplates the present value of each cash flow. A 10-year corporate bond with a coupon of 6% will have a shorter duration than the same maturity bond paying only 3%. If the market interest rate is 4%, and a bond with a coupon of 6% might have its weighted average recovery time or duration for short in this case, may be roughly around 8 years, while another similar maturity but lower weekly coupon at say you know let’s say like three percent that bonds duration could also make sense to be closer to somewhere about nine points five years because high performing cash flow up front then low payments compared against later on down the line.
Specific Differences Between Maturity and Duration
1. Definition
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Maturity: This is the maturity date specified in the bond document. A corporate bond issued in 2024 with a term of 20 years, say, will mature in the year 2044, and this date does not change after the contract is signed.
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Duration: The term for the interest rate risk measure is a weighted average using present value. In general, bonds of longer duration are going to have more interest rate risk. The duration of a bond with a 10-year maturity would be around 7—8 years, assuming that it did not make particularly large coupon payments and interest rates surrounding market rates.
2. Calculation Method
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Maturity: With the maturity explicitly given in the contract, it can be computed directly. A 2020-issued bond with a maturity term of 5 years will mature in 2025, providing a straightforward and confident understanding of the bond’s future.
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Duration: The more intriguing aspect is how the duration is calculated for each cash flow. A basic formula, which takes into account Coupon payments and Market interest rates, is used to calculate its value with the Present Value of Cash Flow. For instance, a bond that is 20 years with a 5% coupon likely has a duration of around ~12 years if the market interest rate is currently at just under half (3%), providing a clear and informed understanding of the bond’s duration.
3. Usage
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Maturity: The maturity tells an investor how much time is remaining until the bond will become due and payable. Suppose an investor purchases a 10-year Treasury bond in 2023. In that case, they are guaranteed that the maturity will occur exactly after these ten years on its due date of maturity at some point during or around May first week or end year.
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Duration: Duration plays a significant role in managing interest rate risk in a bond portfolio. Many fund managers adjust their portfolio duration to mitigate the risk of changing interest rates. Bond portfolios with shorter durations typically experience smaller price drops in a rising interest rate environment, providing investors with valuable insights for their investment decisions.
4. Relationship with Interest Rate Fluctuations
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Maturity: It’s important to note that interest rate changes do not affect the stability of bond maturity. For instance, a corporate bond with a 2030 maturity date will not alter its appearance date due to changes in interest rates. This stability provides investors with a sense of reassurance.
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Duration
