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What Happens When a Bond Matures?
August 30, 2020

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What Happens When a Bond Matures?

Bonds are among the most well-known choices when thinking about where to invest money. Mainly, they are famous for their portfolio diversification functions that can protect themselves from market volatility. Having varied equities help bonds stay afloat when certain economic conditions lead to the downfall of other investments such as stocks and real estate.

Despite this, bond investments still have their own sets of financial risks and challenges. Good thing there are financial and debt relief companies such as DebtQuest USA that can guide you in engaging in productive investments that can provide you with a steady stream of income. We are just a click away to make an appointment with you and start a wealthy investment today.

In this page, we’re going to break down the basics of bonds, by answering your questions as to what exactly is a bond, a bond principal, and what happens when a bond matures.

What Happens When a Bond Matures

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What Is Bond Maturity?

The definition of maturity in bonds and finance basically refers to the time to maturity of a bond. It is the date by which lenders or investors are repaid for the principal value of the bond that they have obtained from the issuer of bonds. Bond repayment during maturity also includes any accrued interest.

For most bonds, interests are typically paid periodically, and the interest paid upon maturity is excluded from the amount paid since last interest payment. But for zero-coupon bonds, also known as municipal bonds, the par value of the bond is paid during maturity plus the total accumulated interest since it was issued.

This feature makes bond investments one of the ideal choices when seeking a steady and passive flow of income. Thus, it is important to take note of bond maturity dates and calculate their expected yields according to the set interest rates and current market prices of bonds.

What Happens When a Bond Matures?

Generally, the issuer of bonds is obliged to repay bondholders of the principal value of the bonds they offered. When a bond reaches maturity, it also stops incurring interests. The length of a bond affects a bond’s yield to maturity.

Can Term to Maturity Change?

There is often confusion when thinking about whether terms to maturity are fixed or still open to change. Most bonds have a fixed term; however, other terms can still be altered if the bond has the following provisions:

  1. Call Provision: This provision gives investors the ability to pay off bonds even before their maturity date. This is often done when there is an expected decline in interest rates, and the advantageous decision would be to repay the bond and issue a newer one at a lower rate of return.
  2. Put Provision: While the former suggests repaying the bond, put provisions enable investors to resell the bond to the bond issuer. This financial decision is frequently made to recoup the money invested in the bond and allot it for offers that are more often than not more beneficial and convincing than the previous one.
  3. Conversion Provision: From the name itself, this provision allows the bondholder to “convert” or transform bond investments to shares of stocks within the company or entity of the bond issuer.

A classic success story of bond issuance was when the Walt Disney Company was able to sum up a whopping $7 billion by selling off bonds. The company provided bonds with six terms of maturity ranging from short-term, medium-term, and long-term variations. The long-term package was a bond with a 30-year maturity period that solicits 0.95% greater than the comparable Treasury bond.

Surely the well-known animations studios company is not the only one to benefit from this massive income. The benefit and profit were also received and enjoyed by the investors that trusted the company with their money. That trust later earned interest and profit.

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What Are Bonds?

Bonds can be seen as loans offered by debtholders or creditors – typically to government agencies, institutions, organizations, or other entities used in financing their projects and operations. In simpler terms, those who offer bonds are considered as borrowers and those who purchase bonds are considered to be lenders.

When availing bonds, specifications of the bond are listed in the issued bond details. It indicates the due date when the principal value is paid, and also includes the agreements on fixed or variable interest payments made by the borrower.

Bonds typically have ratings. High-rated bonds are often those who are considered financially stable and can pay off the debt. Otherwise, low-rated bonds are deemed to be high-risk due to the uncertainty of their financial capability to return the investments given to them.

Long-Term and Short-Term Bonds

In this case, bonds can be broadly classified into two categories according to their term to maturity: (1) short-term bonds and (2) long-term bonds. Long-term bonds are those that take between 12-30 years to mature. It must be noted that the longer the bond is, the higher is its interest rate, and the lower its secondary market price will be.

On the other hand, short-term bonds accrue lower interest rates and provide flexibility to the lender. In a span of a year, the bond will mature and will be repaid. It can then be invested at a much higher rate of return.

How Investors Can Profit From Bonds

Gaining favorable investment returns mainly pertains to how do bonds pay out to the advantage of investors. There are two main ways on how investors can make money from bond investments:

  1. The lender directly purchases the bond, with the objective of holding the bond until its maturity. He or she then can profit off the interest payments made by the debtholder from the issuance of the bond up to its maturity.
  2. Experienced traders of bond enter secondary bond markets and dominate these markets by selling off existing issues at lower face value. The decrease in price essentially depends on the remaining amount to be paid prior to maturity and its corresponding interest rates. If the lender predicts the investment returns of bonds will be lower, selling it in the secondary market would be a more profitable choice to evade the risk of gaining nothing from the investment.

In both scenarios, investors make money from this type of investment through interest payments or what can be referred to as bond coupon payment. If you search for “coupon definition finance” you will see that these are the interest payments lenders receive (can be paid periodically) throughout the duration of the issued bond.

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What Is a Coupon Payment?

Before delving into the processes of how coupons work, let us establish a formal definition of coupons to truly understand. Bond coupons or coupon payments are the annual interests periodically paid on a bond, which are expressed as a percentage of the par value. Bonds often pay a coupon twice a year.

How Do Bond Coupon Payments Work?

Simply put, the pertinent details of a bond, including coupon rate and bond’s face value are already specified upon issuance of the bond.

The investment yields of bonds can be current yield or nominal yield. Traders classify coupon payments as nominal yields because they remain unaffected by shifting market conditions. Consequently, current yields are highly dependent on the suggested market prices and other variable factors surrounding a bond.

The market values of bonds are deemed volatile because they can be traded even before their maturity. For example, an issued bond at $1000 given a 7% yield initially means that both the current and the nominal yield are at 7%. If the investor later trades off the bond at $900, there is an increase in current yield amounting to 7.8% ($7 or $900). The nominal coupon yield remains unchanged.

There are many coupon calculators available online and can be readily used. But if you are confident in performing mental math, the formula in calculating current and nominal yield is as follows:

Coupon rate or nominal yield = annual payments ÷ face value of the bond

Current yield = annual payments ÷ market value of the bond

Bond Pricing and Interests

Bond pricing can get a little tricky. It already follows a formula, and generally works on the principle that lenders may demand a higher rate of return on the bond when there is a high probability of default.

Factors Affecting Bond Prices

In determining your capability to purchase bonds, it is imperative to look into some of the common factors that can affect and predict bond prices.

1.    Interest Rates

Interest rates are inversely related to bond prices; when rates are high, prices are low, and when rates are low, prices are high. Striking a balance and maintaining a relatively low or fair interest rate makes bonds attractive to investors. Otherwise, high interests on bonds might simply drive potential lenders away.

2.    Inflation

This is also inversely related to bond prices. It is mainly because high inflation constrains purchasing power, thereby yielding poor returns on your issued bonds.

3.    Credit Ratings

There are credit rating agencies that give feedback and assign ratings to bond issuers and/or specific bonds. Ratings from reputable agencies can significantly affect the overall reputation of a bond. As previously mentioned, high-rated bonds have higher prices given that despite the increase in price, investors are still interested and are confident in the capability of the issuer to pay off the bond.

Consequently, low-rated bonds settle to lower prices. With their reputation put to question, their only selling point is their affordability.

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Considerations Before Investing in Bonds

Now that you have been familiarized with the basics and fundamentals of bonds, you should also know the crucial considerations before investing in bonds. These guidelines can aid you in determining which bond is worth your dime.

1.    Calculating Potential Return

Predicting the potential return is the main basis of whether or not your investment will be profitable. The best way to determine this is by calculating its yield-to-maturity ratio, which determines the expected return of the bond over its lifetime.

2.    Evaluating Risks

Do not invest in issuers with a history of bankruptcy or insolvency or any red flag that shows that the borrower might be incapable of paying off the bond after all. Also, check market conditions that may affect interest rates and bond market prices.

3.    Identifying Currency Exposure

This may be difficult to do, but assessing your currency exposure is also a great way to ensure the profitability of your investment. Currency fluctuations may add or subtract interest returns.

Make Profitable Bond Investments With Debt Quest USA

Due to the pandemic, economists say that we may be facing an economic crisis that is worse than the recession. This increases doubts of many regarding investments, especially bonds, due to the uncertainty of yielding profitable results. DebtQuest USA offers financial counselling that can guide you towards more informed financial decision-making.

Issuing bonds is still a trend among a myriad of organizations, especially business entities. Thus, it is important to choose a visionary one that can generate huge profits and returns through your bond investments. Feel free to book an appointment with DebtQuest USA now, and you can talk to one of our representatives.

Aside from debt settlement counselling, we can also offer you financial advice on how to make your money grow by lowering your expenses, loans, interest rates, and other payables. We can also help you to invest your money effectively and wisely.

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