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A maturity gap is a term used to describe a strategy that is designed to assess the relationship between the risk of owning assets and liabilities that generate revenue due to interest rate accruals and the volatility of those holdings. The basic idea is to determine if the projected returns on those types of investments, based on performance in the marketplace and the type of interest rate involved, are sufficient to merit the degree of risk that the investor is taking on as part of the ownership of those holdings. While considered a more traditional approach, the maturity gap is less popular than in decades past, with other methods often used to make this type of assessment.
The basic approach of the maturity gap involves evaluating the gap or range that is currently present between the cost of ownership and the benefits realized from the venture. This process actually begins when the investor is considering the purchase of the asset or liability, and involves projecting what will happen with the holding from the date of purchase all the way through to the date that the holding will reach full maturity. A quantification of this type will also involve allowing for any events that could take place, such as an early call on a bond issue, and taking into consideration how that could alter the type of return that is ultimately generated from the holding.
It is also possible to assess the maturity gap at any point during the life of the holding, beginning with the current date and considering the time that will pass until full maturity is reached. Here, the idea is to assess the market value for the holding at strategic points between that current date and the maturity date, then multiply those values by the rate of interest that is anticipated to prevail at those points. For holdings that carry a fixed rate of interest, the process is relatively straightforward. When a floating or variable rate of interest applies, this means not only considering market movements that affect the value of the holding, but also changes in the economy that shift the average interest rate that is used to calculate the returns.
One benefit of using the maturity gap approach is that it helps investors to determine if holding onto the asset or liability is a good idea, or if the time to sell the holding before full maturity would be in his or her best interests. By accurately projecting what is likely to happen between the current date and the next identified point, it is possible to decide whether the asset is performing within an acceptable range or if there is a need to replace it with a different holding. While not the only approach to making this determination, the use of a maturity gap can provide a relatively uncomplicated means of making this assessment, and possibly arming the investor with information that makes it possible to ultimately save a great deal of money.
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