Average maturity

Average maturity

Average maturity is an essential concept in the finance world. It is the weighted average of the maturities of all the outstanding bonds in a portfolio. The average maturity measures a portfolio’s effective maturity, which is vital while judging the portfolio’s risk. 

Here, we provide an overview of average maturity and how it can be used to determine risks.  

What is average maturity?

The average maturity is the weighted average of the maturities of all the outstanding bonds in a portfolio. The weights are based on the market value of the bonds.  

The average maturity is used to measure a bond portfolio’s sensitivity to changes in interest rates. A bond portfolio with a longer average maturity will be more sensitive to changes in   than a bond portfolio with a shorter average maturity. 

Key points of average maturity

• Average maturity displays the average value of the various bonds in a portfolio’s maturity dates. The weights show the percentage of each bond’s importance in the entire portfolio. 

• The time until the primary investment is returned to the security holder is the maturity or duration of a bond. The word maturity, which describes how long it takes to pay back a loan, is also used. 
• The time between the bond’s issuance date and redemption date is hence its maturity.  
• Interest rates and bond prices are inversely correlated. Bonds with fixed rates cost more when interest rates are lower and vice versa. 
• Compared to short-term bonds, longer-term bonds have higher interest risk.

Average maturity and interest rate risk

Interest rate risk arises from the fluctuations in interest rates. When interest rates rise, the value of investments falls, and vice versa. This risk is especially relevant for investments with a long average maturity, such as bonds. 

Bonds are often referred to as fixed-income securities because the payments they provide (coupons) are fixed. However, the prices of bonds fluctuate in response to changes in interest rates. Remember, bond prices decrease when interest rates increase, and vice versa. 

The interest rate risk of a bond is measured by its duration. The longer the duration, the greater the interest rate risk. For example, a bond with 20 years will be more sensitive to changes in interest rates than a bond with a 10-year duration. 

There are several ways to manage interest rate risk. One is to avoid investments with a long duration and another is to use hedging techniques, such as interest rate swaps. 

What is the average maturity of a debt (fixed income) Mutual fund?

Debt mutual funds invest in a portfolio of debt securities, such as government bonds, corporate bonds, and other fixed-income instruments. The average maturity of a mutual debt fund is the average length of time to maturity of the securities in the fund’s portfolio.  

The average maturity of a mutual debt fund can range from a few months to several years. Short-term debt mutual funds typically have an average maturity of 1-3 years, while intermediate-term and long-term debt mutual funds have an average maturity of 5-10 years or more. 

Investors seeking stability and income typically invest in debt mutual funds with a longer average maturity. These funds tend to have more volatile returns but offer higher potential yields.  

How is the average maturity of a debt (fixed income) Mutual fund calculated?

You must use the weighted average method to estimate how long it will take for each bond in the fund’s portfolio to mature to compute the average maturity of a debt fund. 

Let’s take an example where a debt fund purchases three bonds having face values of $30, $50  and $60. The average maturity calculation of the debt fund will be as follows if the period to maturity for these bonds is 3 years, 4 years, and 5 years, respectively: 

Calculation: 

Average Maturity of the Debt Fund portfolio  

= WT of (Bond 1 + Bond 2 + Bond 3) / FV of (Bond 1 + Bond 2 + Bond 3)  

= ($60+ $150+ $300) / ($30+ $50+ $70)  

= 3.4 years. 

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