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Often associated with a term bond, balloon maturity is a situation that occurs when the maturity date of a bond or set of bond issues takes place in a calendar year, with the result being an unusually high amount of bond principal being realized. Here is some information about how balloon maturity works, and why the approach may be a good fit for both the issuer and the investor.
Balloon maturity is usually associated with a bond issue that has a single and fixed maturity date. Rather than quoting the value of the bond in terms of price, the worth is quoted in yield expected at the maturity date. In order for the balloon maturity strategy to work, the issuer of the bond agrees to a repayment schedule that is considered equitable to both the investor and the issuer. The repayment on the issue of bonds proceeds along at a rate that is not unlike any type of bond transaction.
What is different is that the issuer agrees to make the payments into a sinking fund that helps to ensure the redemption of the term bonds. This proceeds contained within the sinking fund may be used before the balloon maturity is reached in some cases, but the main purpose is to endure that there are resources to meet the balloon maturity on the agreed upon maturity date.
The utilization of the balloon maturity approach can be beneficial for both the issuer of the bonds and the investor. Typically, the series of payments that are made for most of the duration of the bond are substantially lower than would take place with a standard business loan. This means that the issuer has a great deal of flexibility in devising means to meet the maturity date. Part of this process is accomplished with the use of the sinking fund as a means of gathering the resources. Ideally, the sinking fund will carry a rate of interest that exceeds the anticipated yield from the transaction.
For the investor, the utilization of a balloon maturity strategy is a relatively safe investment to make. The presence of the sinking fund helps to ensure that repayment will take place, and that there will be some increase garnered from the final yield on the date of maturation. This means not only recovering the principle investment, but also making a nice amount of additional revenue from the project.