Maturity risk refers to the chance that a bond will lose value before it gets paid back. When you buy a three-month bond, you get interest for three months, then get your money back. With a 30-year bond, you get interest for 30 years, but you don't get your money back for 30 years. The odds are that there's a much greater risk of something bad happening in 30 years than in three months. The company or government issuing the bond could fail and not pay you back or interest rates could go up, making your bond worth less.
Maturity risk is one of the reasons that investments pay a return -- to compensate you for taking the risk of investing. It is also why returns usually go up as the length of the investment grows, since you're taking more maturity risk by putting off the eventual return of your money. A maturity risk premium refers to the amount of extra return that the investment pays for having a longer term.
A graph that plots returns on investments relative to their lengths is called a yield curve. Usually, the yield curve slopes upward and shows longer bonds offering a higher return than shorter bonds. For instance, on January 9, 2014, the yield on the one-year Treasury was 0.13 percent, the yield on the five-year was 1.75 percent and the yield on the 30-year was 3.88 percent, according to the Department of the Treasury. In some instances, the yield curve can invert, and longer-term bonds can pay lower rates than shorter-term ones, creating a negative risk premium. Usually, this happens because investors expect rates on short-term bonds to fall. This can be an indication of a recession.
Sometimes, even short-term bonds can have negative yields. When this happens, you actually earn less by investing your money than by leaving it under your mattress or in a non-interest bearing account. According to Bloomberg, on September 26, 2013, three-month treasury bills traded at -0.0051 percent, meaning that the maturity risk premium for investing $1 million with the government for three months instead of keeping it elsewhere would be $12.75 (0.0051 percent of $1 million is $51, which works out to $12.75 over three months). In essence, you'd be paying the government to keep your money safe for three months.
In essence, the service charges and fees that you may pay for bank accounts, brokerage accounts or depository accounts are a negative risk premium. Instead of holding onto your money or precious metals, you pay an institution to hold them for you since you feel it's safer to have the assets under the control of that third party. A withdrawal from those accounts is functionally the same thing as the maturity of a bond, so you're essentially paying a negative risk premium.
- Dollar Bank: What Is the Relationship Between Maturity, Risk and Interest Rates?
- ZeePedia.com: Term Structure of Interest Rates
- Greg Mankiw's Blog: What Does an Inverted Yield Curve Mean
- Department of the Treasury: Daily Treasury Yield Curve Rates
- Bloomberg: Negative Rates on Treasury Bills Show Little Debt-Limit Concern
- Creatas/Creatas/Getty Images