What is a Maturity?
Maturity is the date on which a bond or preferred stock issuer must repay the original principal borrowed from a bondholder or shareholder.
How Does a Maturity Work?
Let's assume that on January 1, 2000, you purchased an XYZ Company bond that had a 10-year maturity. That means that on January 1, 2010, XYZ Company will pay you (or whomever you happen to sell the bond to) the face value (also called the par value) of the bond. The face value is essentially the size of the I.O.U. represented by the security certificate. That is, the face value is the original principal lent to the company. Bond face values are usually $1,000, and preferred stock face values are usually $25.
Some bond and preferred stock maturities are short-term (a year or less), others are intermediate-term (usually two to 10 years) and many are long-term (a period of 10 to 30 years or more). Bonds with maturities of less than 10 years are typically called notes.
Sometimes investors get their original principal back before the maturity date. This usually happens when the issuer takes advantage of special provisions that a security might have. For example, call provisions allow an issuer to redeem, or call, a bond or preferred stock before it matures. Issuers like this provision because if interest rates fall they can pay off the securities with proceeds from new securities issued at a lower interest rate. Investors don't always welcome this because they lose their ability to collect what could be above-market interest payments and they may have to reinvest the money from their redeemed securities at a lower interest rate. To compensate investors for these risks, issuers of callable bonds usually agree to pay more than the face value depending on when the securities are redeemed.
Another example is the sinking fund provision, which requires the issuer to make payments to a trustee while the securities are outstanding. The trustee then uses the funds to repurchase some or all of the securities on the open market.
Usually issuers control whether a security is redeemed before it matures, but in some cases, investors can control this process. A convertible bond, for example, gives the bondholder the option to exchange the bond for a predefined number of securities (usually the issuer's stock) at some future date and under prescribed conditions. An exchangeable bond, on the other hand, allows the bondholder to exchange the bonds for the stock of a company other than the bond issuer. Putable bonds and preferred stocks allow their holders to force the issuer to redeem the security at a set price under certain conditions.
Why Does a Maturity Matter?
The maturities of bonds and preferred stocks are very important. Not only do they tell investors when they will be repaid, they are crucial to mathematically determining the appropriate price of the security. This is because the formulas used to price these securities often involve finding the present value of that future return of principal. The longer the investor has to wait for the return of his capital, the less the security tends to be worth.
It is important to note that just because a bond will pay a certain amount at maturity doesn't mean that’s what the bond is worth today. Often, investors can purchase bonds for more or less than face value. For instance, if the Company XYZ bond has a $1,000 face value, it still may only be worth $800 today, or it may be worth $1,500 today depending on market conditions, coupon rates and whether there are any special provisions like those described above.
Even more important is that the presence of a maturity date does not guarantee that the investor will get his money back on that date. For all bonds and preferred stocks (except Treasuries) there is always some chance the issuer will default.
