Held to Maturity

Overview


Held to Maturity securities are investments that are purchased primarily to receive the interest from the investment, with no intent to sell the security prior to maturity.

Treatment


Held to Maturity investments are held at amortized cost on the books. Changes in the market value of the asset are not recognized.

Classification


To classify for held to maturity treatment, a company must have both the intention and the ability to hold the given investment to its maturity date.

The company does not have the intention to hold to maturity if it is willing to trade the security in certain circumstances.

The company does have the ability to hold the security to maturity if there is a call provision embedded in the asset, such that the issuer of the security and call it prior to maturity.

Premium/Discount


Typically a bond's interest rate will not match the prevailing interest rate in the markets. This can be for several reasons. Market rates will fluctuate on a daily basis, so issuing a bond to have the prevailing rate exactly as it ocurred on the issue date is not practical. In addition, bonds can be bought and sold on the secondary market after issuance, meaning that the prevailing rates when the bond is purchased will not in general be the same as those at the time of issuance.

When a bond is purchased at a dollar amount different from the par value (typically, the principal value), the bond is set to be bought at a premium or a discount.

When a bond is more expensive than the par value, the premium is
{% premium = price - par \, value %}


When a bond is less expensive than the par value, the discount is
{% discount = par \, value - price %}
The par value of the bond is recorded in the bonds as the bond's value. But then an account is created to record the premium or discount.

For example, if a $100 par value bond paying a 10% interest rate is purchased at $110, we will have the following

  • Par Value = $100
  • Premium = $10
Because premium is a contra account, the toal asset value here is $110.

The stated interest rate is 10%, so the bond will pay $10 every year in interest. However, for the sake of accounting, this $10 is not all interest. That is, because the bond was bought at a value over $100, the holder will not receive an effective rate of 10%.

The way this is handled is to take a fraction of the interest paid, and use it to amortzie the bond premium.

Calculating
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