Held-to-maturity securities are debt security held by an investor until maturity.
HTM securities provide investors with a stable source of income and may be a good option for those looking for a more conservative investment.
These fixed-income securities have unique features and benefits, making them an attractive investment option for many investors.
This comprehensive blog post will explain what HTM securities are, how they work, their advantages and risks and if it fits your investment strategy well.
What are Held-to-Maturity Securities?
Held-to-maturity securities are bonds, notes, or other debt securities usually issued by corporations or governments and pay a fixed interest rate.
When an investor purchases an HTM security, they agree to hold it until its maturity date. At this point, the issuer will repay the face value of the security along with any remaining interest payments.
Unlike trading securities or available-for-sale securities, which are bought and sold based on market conditions, HTM securities are held until maturity, regardless of changes in market value. The investor of HTM securities is guaranteed to receive the face value of the security at maturity as long as the issuer does not default.
How do Held-to-Maturity Securities Work?
When an investor purchases an HTM security, they typically receive a fixed interest income for the life of the security. The issuer determines this interest rate based on various factors, including the current market interest rate, the issuer’s creditworthiness, and the security’s maturity date.
The most prevalent type of held-to-maturity (HTM) investments are bonds and other debt instruments such as certificates of deposit (CDs). These investment vehicles possess a pre-determined payment schedule and a fixed maturity date.
Companies have different classifications to categorize their debt and equity securities investments for accounting purposes. These classifications include “held-to-maturity”, “held-for-trading”, and “available for sale” securities, among others.
The company’s financial statements treat these classifications distinctively concerning their investment value and related gains and losses.
Therefore, it is crucial for companies to accurately classify their investments to provide investors with a clear and transparent representation of their financial performance. Failure to do so can lead to misleading financial information, which may negatively impact investor confidence and trust in the company’s financial reporting.
How are HTM securities valued?
As per accounting standards, HTM securities with a one-year or less maturity date are recognized as current assets.
Conversely, securities with maturities exceeding one year are classified as long-term assets. They reflect on the balance sheet at their amortized cost, including the initial acquisition cost and any additional expenses incurred.
It’s essential to understand the accounting treatment of held-to-maturity securities. These securities are recorded on the balance sheet at their carrying value and are not marked to market at the end of the period. Therefore, the financial statements do not recognize any unrealized gains or losses. Instead, the security is amortized over its expected period until maturity. The unrealized gains and losses (changes in market value before the securities are sold) are recognized in the income statement.
Any short-term price fluctuations are not reflected in corporate accounting statements, while interest income is reported on the income statement.
Debt securities that fall under the trading category are stated at their fair value. Any unrealized gains and losses are reported in the income statement every period.
This categorization approach allows for a better assessment of the company’s financial position and assists investors in making informed decisions about their investment choices.
Types of Held-to-Maturity Securities
Held-to-maturity securities are classified into various types based on their characteristics. The most common types include:
Government Bonds
Government bonds are debt instruments issued by the government to finance its budget deficits, build infrastructure, or spend on public welfare. These securities are considered low-risk and one of the safest investments, as they have complete faith and the government’s credit.
Buying a government bond means you lend money to the government and earn contractual cash flows (coupon payments) based on a fixed interest rate and the payment frequency of the bond. Government bonds are popular amongst those seeking a stable investment option with minimal risk.
Corporate Bonds
Corporations issue corporate bonds to raise funds for various purposes, such as capital investments or debt refinancing. These bonds are generally riskier than government bonds, as the government does not guarantee its return.
The level of risk varies depending on the creditworthiness and overall financial health of the company issuing the bond. So it becomes critical to do your research before investing in corporate bonds. However, corporate bonds are a lucrative investment for people based on their risk appetite.
Municipal Bonds
Municipal bonds are debt securities issued by local or central governments to raise funds for building schools, highways, hospitals etc. These bonds are considered low-risk debt investments backed by the government to protect the creditors (the bondholders) from default risk.
Like corporate bonds, a certain level of risk is associated with municipal bonds, depending on the financial health of the issuer government. Investors can consider them as a part of their investment portfolio if they seek tax benefits due to tax exemption offered by the federal.
Advantages of Held-to-Maturity Securities
Investing in Held-to-Maturity (HTM) securities has many advantages that can provide bondholders financial security and stability.
Predictable Income
One of the main advantages of HTM securities is that they provide investors with a predictable source of income.
Because investors know the interest rate and the security’s maturity date, they can accurately predict the income they will receive from the investment. Investors can expect a steady income stream from their investments till the maturity of the securities.
Low-risk, less Volatile
Another key advantage of HTM securities is that they are low-risk investments. Unlike stocks, which can fluctuate rapidly in value, HTM securities offer a fixed rate of return over the investment horizon.
These securities are typically issued by governments or companies with solid credit ratings, making them a relatively safe investment option. With HTM securities, investors can enjoy peace of mind knowing that their money is secure and less unlikely to suffer significant losses.
Because HTM securities are held until maturity, they are not subject to fluctuations in market value unless the interest rate rises abruptly due to specific economic conditions. It reduces the volatility of an investor’s portfolio, making it a more conservative investment option.
Portfolio Diversification
Investing in HTM securities can also help diversify an investor’s portfolio. HTM provides a stable and predictable income that can help reduce the volatility of the investment portfolios.
Investing all your money in high-risk financial assets like stocks and hedge funds may make your investment portfolio vulnerable.
You may suffer a significant loss if those investments take a sudden dive. However, when your portfolio is diversified across all other asset classes such as a commodity, real estate, bonds (Held to Maturity, for example), stocks etc., you are more likely to have a balanced portfolio with stable returns.
That sense of security can be compelling, especially in a world where financial markets can be unpredictable. It will give you a better sleep, knowing that even if the market takes a turn for the worse, you have some protection.
Understanding the importance of due diligence and research before investing is obvious, as held-to-maturity securities are not a panacea. But, as a tool for diversification, HTM securities are valuable.
Risks Associated with Held-to-Maturity Securities
While held-to-maturity securities can offer several benefits to investors, they come with risks. Some of the potential risks associated with these securities include:
Interest Rate Risk
When considering an investment in bonds, investors who plan to hold them until maturity can be confident in the predictability of their final return. This is because, in the case of Held to Maturity securities, interest rate risk becomes negligible when investors decide to hold the security till maturity.
When it comes to held-to-maturity investments, the risk becomes more significant if the investment is not held until maturity. This is because the price of held-to-maturity security is based on the interest rate at the time of purchase. If interest rates rise after the purchase, the security’s market value will decrease; if interest rates fall, the market value will increase.
If the held-to-maturity investment is sold before its maturity date, the investor may incur huge losses due to changes in interest rates. This is because the security price is based on the prevailing interest rates at the time of sale, which may be lower than the interest rate at the time of purchase.
The recent failure of Silicon Valley Bank is a perfect example that resulted from rising interest rates affecting the value of their significant investment in held-to-maturity debt securities.
Therefore, it is crucial for investors to carefully consider their investment goals and time horizon when purchasing held-to-maturity securities.
By holding these investments until maturity, investors can effectively manage interest rate risk and achieve their financial goals without worrying about an unexpected fall in the market value of their holdings. It is essential to conduct thorough research and seek professional advice before investing to ensure a profitable investment strategy.
Default Risk
Another potential risk associated with held-to-maturity securities is default risk, which is the possibility that the issuer fails to make its interest payments or repay the principal amount at maturity.
Default risk is higher for corporate bonds than government or municipal bonds, as corporations are more likely to default on debt obligations than governments during financial hardship or economic downturns.
As an investor, the default risk can be terrifying. The investors may lose the entire investment if the issuer defaults. Moreover, when the issuer defaults, the risk can be even bigger because holding onto the security until it matures means you don’t have the option to sell it if things go south.
That said, it’s important to remember that default risk isn’t a death sentence for held-to-maturity securities. With proper research and due diligence, investing in high-quality investment-grade securities can minimize risk and protect your investment.
It’s all about striking the right balance between risk and reward and being willing to take a critical look at your investment strategy. So while default risk is a genuine concern regarding held-to-maturity securities, it should not be the reason to avoid them altogether.
Inflation Risk
The significance of Inflation risk is a concern when it comes to held-to-maturity investments. While these debt securities offer stability, they’re not immune to the effects of inflation as the returns are not inflation adjusted.
With rising prices, the purchasing power of the income generated by these investments erodes. Understanding the inflation risk while considering these types of investments is essential. Ensure you have a diversified portfolio with assets that protect against inflation, such as TIPS.
Conclusion
In conclusion, held-to-maturity securities can be a valuable tool for investors looking to balance out the risks and rewards of their portfolios.
These securities can offer tax benefits and are generally considered low-risk investments, although they are not without potential risks.
It’s crucial to do your research, consult with a financial advisor, and maintain a diversified portfolio that includes a variety of assets that can protect against associated risks.
These investments can achieve long-term financial stability and growth with the right approach.