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Understanding Term Structure

In fixed income every security has a predefined period of time (term) that you as the investor is lending your money. Term is generally measured by three different parameters: the call date, the maturity date or no maturity (perpetual).

• At the call date, the bond can be redeemed at the discretion of the issuer before maturity;
• At the maturity date, the principal of bond becomes due and the issuer is legally obliged to repay par value back to the investor;
• If a security has no maturity date, it is classified as perpetual and is typically left outstanding until called by the issuer.

 

Figure 1. The Relationship Between Term and Certainty of being Redeemed

term

 

As callable securities (including perpetual securities) are redeemable at the issuer’s discretion, there is no legal obligation for the issuer to redeem. Therefore, these types of securities are much more uncertain than securities with a fixed maturity date (and obligatory redemption). As a result, when calculating return (yield), an investor must subjectively determine the likelihood of redemption.