Maturity Distribution

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority and you can order it here)

In high-grade bond holdings, the diversification of maturities as to short-term, intermediate-term, and long-term, aiming at a straddle on the problem of open market price depreciation versus normally higher yields on longer-term maturities.  The market prices of high-grade bonds respond inversely to fluctuations in money rates and yields on high-grade paper and obligations, i.e., when interest rates, open market money rates, and yields on such obligations rise, their open market prices decline in order to afford higher yields, because the rate of interest payments that such bonds pay is fixed as of the time of their issuance.

Moreover, because normally long-term maturities yield more than short-term maturities, a given magnitude of change in money rates and yields will have more impact on long-term high-grade bonds, and hence on their open market prices, than on short-term maturities.  The latter, therefore, are more stable in open market prices, normally, than long-term maturities; in addition, they can be more easily held to the final short-term maturity, allowing one to bypass the problem of open market price depreciation by pre-planned holding to final maturity.

Thus long-term maturities normally yield more but are more vulnerable to open market depreciation, should money rates and yields on high-grade obligations rise in the intervening years before final maturity and should they have to be sold instead of held to final maturity.  Of course, if long-term high-grade bonds can be held readily to final maturity, the problem of open market price depreciation in the intervening years will be bypassed, since there should be no question of payment in full of high-grade obligations at final maturity, and since institutional investors such as commercial banks (see COMPTROLLER’S REGULATION) and life insurance companies may carry such high-grade bonds at book values (less amortization of premium in cost if any), thus ignoring open market depreciation if any.

A completely short-term maturity concentration (e.g., maturities of under one year) will normally entail lower yields and hence lower income from investments, a particular problem when investments constitute the bulk of earning assets, but it provides highest protection against open market depreciation in the event of sale before maturity (so-called money risk or interest risk rate).  On the other hand a completely long-term maturity concentration will provide higher yields and hence income from investments, but greatest exposure to risk of open market depreciation in the event of sale before final maturity.  Spacing maturities in a diversified manner among shorts, intermediates, and longs, therefore, provides the following advantages:  (1) overall yields on the portfolio are improved, (2) in the course of time, the maturity of the shorts periodically provides funds for reinvestment in longs at prevailing yields, (3) the portfolio will always have a layer of shorts as a secondary reserve which, in the event of required sale, will have least risk of open market depreciation.

Execution of a program of maturity distribution requires the availability of desired maturities in the market.  Such diversification of maturities is available particularly in U.S. government securities.  

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