Constant Maturity

What Is Constant Maturity?

Constant maturity is an adjustment for equivalent maturity, utilized by the Federal Reserve Board to compute an index in view of the average yield of different Treasury securities maturing at different periods. Constant maturity yields are utilized as a reference for pricing different sorts of debt or fixed-income securities. The most common such adjustment is the one-year constant maturity Treasury (CMT), which represents the one-year yield equivalent of the most recently auctioned Treasury securities.

Constant Maturity Explained

Constant maturity is the theoretical value of a U.S. Treasury that depends on recent values of auctioned U.S. Treasuries. The value is obtained by the U.S. Treasury consistently through interpolation of the Treasury yield curve which, thus, depends on closing bid-yields of actively-traded Treasury securities. It is calculated utilizing the daily yield curve of U.S. Treasury securities.

Constant maturity yields are often utilized by lenders to determine mortgage rates. The one-year constant maturity Treasury index is one of the most widely utilized, and is predominantly utilized as a reference point for adjustable-rate mortgages (ARMs) whose rates are adjusted yearly.

Since constant maturity yields are derived from Treasuries, which are considered risk-free securities, an adjustment for risk is made by lenders through a risk premium charged to borrowers as a higher interest rate. For instance, in the event that the one-year constant maturity rate is 4%, the lender might charge 5% for a one-year loan to a borrower. The 1% spread is the lender's compensation for risk and is the gross profit margin on the loan.

Constant Maturity Swaps

A type of interest rate swaps, known as constant maturity swaps (CMS), permits the purchaser to fix the duration of received flows on a swap. Under a CMS, the rate on one leg of the constant maturity swap is either fixed or reset periodically at or relative to London Interbank Offered Rate (LIBOR) or another floating reference index rate. The floating leg of a constant maturity swap fixes against a point on the swap curve on a periodic basis with the goal that the duration of the received cash flows is held constant.

As a general rule, a flattening or an inversion of the yield curve after the swap is in place will further develop the constant maturity rate payer's position relative to a floating rate payer. In this scenario, long-term rates decline relative to short-term rates. While the relative positions of a constant maturity rate payer and a fixed rate payer are more complex, as a general rule, the fixed rate payer in any swap will benefit fundamentally from a vertical shift of the yield curve.

For instance, an investor accepts that the general yield curve is about to steepen where the six-month LIBOR rate will fall relative to the three-year swap rate. To take advantage of this change in the curve, the investor purchases a constant maturity swap paying the six-month LIBOR rate and getting the three-year swap rate.

Constant Maturity Credit Default Swaps

A constant maturity credit default swap (CMCDS) is a credit default swap which has a floating premium that resets on a periodical basis, and gives a hedge against default losses. The floating payment relates to the credit spread on a CDS of similar initial maturity at periodic reset dates. The CMCDS contrasts from a plain vanilla credit default spread in that the premium paid by the protection buyer to provider is floating under the CMCDS, not fixed similarly as with a normal CDS.

The One-Year Constant Maturity Treasury

The one-year constant maturity Treasury (CMT) is the interpolated one-year yield of the most recently auctioned 4-, 13-, and 26-week U.S. Treasury bills (T-bills); the most recently auctioned 2-, 3-, 5-, and 10-year U.S. Treasury notes (T-notes); the most recently auctioned U.S. Treasury 30-year bond (T-bond); and the off-the-run Treasuries in the 20-year maturity range.

Highlights

• Constant maturity additionally factors in to certain types of swaps contracts to standardize the cash flows owed or due on the swap agreement.
• Constant maturity interpolates the equivalent yields on bonds of different maturities to make related things correlations.
• Constant maturity adjustments are commonly seen in calculating U.S. Treasury yield curves as well as in computing rates on adjustable mortgages.