Held to maturity securities
| Held to maturity securities |
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The definition of held to maturity securities determines debt investments like bonds or notes, that a company contemplates holding until their maturity date. Mainly held to maturity securities are purchased to earn interest revenue. A held to maturity security if will mature within a year so in the report it is as a current asset on the balance sheet. Noncurrent assets are reported if held to maturity securities maturing beyond a year. Only securities with maturity dates like bonds and corporate notes are classified as held to maturity securities. Equity securities do not have a maturity date because they are not held to maturity securities. Held to maturity bond investments are registered at their cost. If the interest rate on the bonds is different from the market rate of interest, the bonds might be purchased at a discount or premium. In such cases, the discount or premium is amortized over the life of the bonds as a decrease ( premium) or an increase (discount) to the investment account. Investments held to maturity bond are reported on the balance sheet at their amortized cost[1].
Held to Maturity Securities (amortized cost)
This category includes only requires the positive intent, capacity to hold the securities to maturity (not only an absence of intent to sell) and debt securities. Held to maturity securities are carried at amortized cost (purchase cost adjusted for amortization of discount or premium) using effective interest method, therefore losses and unrealized holding gains are not reported. However, realized losses and gains are included in earnings, the same as:
- an interest premium,
- income and
- discount amortization.
Foregoing securities are classified on the balance sheet as noncurrent or current on an individual basis and on the pronouncement of cash flow as investing activities. Rarely, the intention of the investor company's hold a security to maturity might change without casting doubt on its purpose for holding other debt securities to maturity. The circumstances have to be unforeseeable and nonrecurring such as the continuing deterioration of the issuer's credit. Held to maturity securities of premature sale might be considered as maturities if also of the following conditions is met[2]:
- the sale takes place so close to the maturity date that interest rate risk is nearly eliminated, or
- the sale takes place after at least 85% of the principal has been collected.
Are held to maturity securities profitable?
Held to maturity securities have predetermined return which is not dependent on market changes. They are associated with low risk level. As the date and sum of return is known, it is easier to create financial plans. However, it is very difficult to sell them before the date and the return isn't very high (low risk, low profit). The investor should calculate which type of securities is more profitable for him[3].
Examples of Held to maturity securities
- Bonds: Bonds are debt securities in which an investor loans money to an entity such as a government, municipality, or corporation. Bonds are issued for a fixed period of time, typically paying a fixed rate of return. Bonds held to maturity are reported on the balance sheet at their amortized cost.
- Notes: Notes are similar to bonds, but they typically have shorter maturities and are issued by corporations. They are often used to finance short-term projects or investments. Notes held to maturity are reported on the balance sheet at their amortized cost.
- Certificates of Deposit (CDs): CDs are deposit accounts offered by banks and credit unions. They typically pay a fixed rate of return for a specified period of time. CDs held to maturity are reported on the balance sheet at their amortized cost.
Advantages of Held to maturity securities
The advantages of held to maturity securities are the following:
- They are low risk investments that provide steady income from interest payments.
- They provide a steady and predictable income stream, which can be beneficial for investors looking for a reliable source of income.
- They are often less volatile than other investments, such as stocks or commodities.
- They are relatively easy to understand and provide investors with a known return.
- They can be a good option for investors looking for a safe and secure investment.
- The market value is usually close to the original purchase price, so there is usually no need to worry about market fluctuations when investing in held to maturity securities.
- They provide investors with the ability to diversify their portfolios.
Limitations of Held to maturity securities
The limitations of held to maturity securities are:
- It is difficult to re-sell held to maturity securities as they are allowed to be sold only on maturity.
- Such securities are not liquid which means it is not possible to get cash quickly in case of emergency.
- If the interest rates increase, it is difficult for investors to take advantage of the situation as these securities cannot be sold before maturity.
- Held to maturity securities are usually associated with higher risk because the investor is obligated to hold them until their maturity date.
- These securities are not suitable for investors who are looking to diversify their portfolio due to the unavailability of options.
The following are other approaches related to held to maturity securities:
- Fair Value Option: Under the Fair Value Option, companies have the option to report investments in held to maturity securities at fair value. This eliminates the need to amortize the premium or discount, which can result in more accurate financial statements.
- Available for Sale: Investments that are not held to maturity and have no fixed maturity date can be reported under the available for sale designation. These investments are reported at fair value, with unrealized gains and losses included in the equity section of the balance sheet.
- Trading Securities: Trading securities are investments that are bought and sold in the short-term to generate a profit. These investments are reported at fair value, with the changes in fair value reported in the income statement.
In summary, held to maturity securities are debt investments that are held until maturity, and are reported at their amortized cost. Other approaches related to held to maturity securities include the Fair Value Option, Available for Sale, and Trading Securities, which are reported at fair value and the changes in fair value reported in the income statement.
Footnotes
References
- Najeeb S.F., Bacha O., Masih M. (2017)., Does a held-to-maturity strategy impede effective portfolio diversification for Islamic bond (sukuk) portfolios? A multi-scale continuous wavelet correlation analysis. Emerging Markets Finance and Trade, 53(10), 2377-2393.
- Smith T. (2011)., CPA 2012 FAR, T.Smith
- Warren C., Reeve J.M., Duchac J. (2016)., Financial and Managerial Accounting, Cengage Learning
Author: Alicja Ryszka
