Final answer:
Bond maturity relates to risk as the bond's attractiveness to investors and its present value change over time with fluctuations in market interest rates and as the bond approaches its maturity date.
Step-by-step explanation:
The relationship between bond maturity and risk can be explained by observing how interest rates impact the value of bonds to investors over time. Bonds are essentially debt securities that are issued when companies want to raise money. A bond includes a face value, a coupon rate or interest rate, and a maturity date. The value of a bond fluctuates based on market interest rates, which can make a bond more or less attractive to investors.
For instance, if a bond is issued at a 5% interest rate when market rates are also at 5%, the bond would be considered attractive, providing a $50 annual payout on a $1,000 bond. If market rates fall to 3.5%, the bond's 5% rate becomes more attractive, often causing investors to buy the bond until the yield aligns with prevailing rates. Conversely, if market rates rise to 6.5%, a bond with a 5% coupon becomes less attractive, and its price may fall since investors could get a better return elsewhere.
As bonds approach maturity, the interest rate risk tends to decrease, but other risks like default risk could potentially increase if the issuer's financial condition worsens. Therefore, the bond's risk profile changes over time as its maturity date gets closer and as market interest rates fluctuate, affecting its present value and attractiveness to investors.