What are Held to Maturity Securities?
Held to maturity securities are securities that companies purchase and intend to hold until they mature. This is unlike trading securities or available for sale securities, where companies don’t usually hold on to securities until they reach maturity. Companies mostly use these investments to protect themselves against interest rate fluctuations, diversify their investment portfolios, and realize a small, low-risk capital gain over a longer period of time. Held to maturity securities are usually debt instruments such as government or corporate bonds.
Pros and Cons of Held to Maturity Securities
- Securities that are to be held until maturity are usually very low risks. Assuming that the bond issuer does not default, returns are essentially guaranteed.
- They are not susceptible to news events or industry trends since the returns on a bond are already pre-specified at the time of purchase (i.e., the coupon payments, face value, and maturity date).
- Investors are able to plan their investment portfolios for the long term and count on bonds as lower-beta securities that will diversify the risk that their portfolio faces.
- Held to maturity securities bite into the company’s liquidity. Since companies make the commitment to hold these securities until maturity, they cannot really count on these securities to be sold f cash is needed in the short term.
- As discussed above, the returns on these securities are pre-determined, meaning that while there is downside protection, there is limited upside potential. If financial markets generally go up, the company’s returns will not be positively affected.
The biggest difference between held to maturity securities and the other security types mentioned above is in their accounting treatment. As opposed to being recorded and updated on the company’s balance sheet according to the security’s fair market value, held to maturity securities are recorded at their original purchase cost. This means that from one accounting period to another, the value of the securities on the company’s balance sheet will remain constant.
Any gains or losses resulting from changes in interest rates (for bonds and other debt instruments) will be recorded when the securities reach maturity. Below is an example of how a 2-year bond will appear on a company’s balance sheet:
Upon purchase, the offsetting account will likely be cash, as the company likely bought the securities with cash. Here, we can see that no changes are recorded in the 2017 accounting period, despite any changes in the fair value of the security during that time period. For instance, if interest rates fell sharply in 2016, which would cause a rise in the market value of the bond, there would be no account of this in the company’s balance sheet.
In 2018, when the bond matured, we see that a capital gain of $500 million has occurred as a result of sliding interest rates. This is the only time that any changes in the value of the security will be recorded.
Interest payments made to the debt-holding company will appear in the company’s income statement on a periodic basis. Let’s assume that the bonds pay a 10% annual coupon rate, which equates to $50 million in additional income each year. Here’s how this would look on a company’s income statement:
Here, we can see how the 10% coupon is captured in the interest line item. For simplicity, it is assumed that the company does not have any other interest revenues or obligations to its financiers. Thus, the interest from coupon payments is recorded as a negative number since the “interest” account assumes that companies will usually have to make more interest payments than receive coupon payments.
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