As a professional, it is important to understand the jargon of financial terms, especially those that are used interchangeably but have different meanings. One such term is “maturity,” which is a crucial aspect of fixed-income securities. Two types of maturity commonly used in finance are contractual maturity and residual maturity.
Contractual maturity refers to the date on which the issuer of a fixed-income security is obligated to repay the principal amount borrowed from the investor. It is the pre-determined and agreed upon date that is mentioned in the bond or certificate of deposit (CD) agreement. Generally, it ranges from a few months to several decades, depending on the type of fixed-income security.
Once the contractual maturity date arrives, the issuer must repay the principal amount plus any interest accrued over the term of the security. It is important to note that there is usually no penalty if the issuer pays off the obligation early.
Residual maturity, on the other hand, refers to the time until the final payment for a bond or CD is due. Unlike contractual maturity, it is not a fixed date but rather a moving target that changes over time. It is calculated by subtracting the current date from the contractual maturity date.
As a bond or CD approaches its contractual maturity, the residual maturity decreases until it reaches zero on the date of maturity. For example, if a bond has a contractual maturity of 10 years and the current date is 5 years after the issuance date, then the residual maturity is 5 years.
Many investors use the residual maturity to evaluate the risk and profitability of a fixed-income security. A bond or CD with a longer residual maturity is generally considered riskier, as there is a higher possibility of default or interest rate changes affecting the investment. However, it may also offer a higher yield or return potential.
In conclusion, while contractual maturity and residual maturity are both important concepts in fixed-income securities, they have different meanings and uses. Contractual maturity refers to the date on which the issuer is obligated to repay the principal amount borrowed, while residual maturity is the time until the final payment is due. As a professional, it is essential to understand the jargon of financial terms to help writers convey their message accurately to their audience.