Tenor

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Understanding Tenor

Tenor is the length of time remaining before a financial contract or instrument expires. It is commonly used for loans, insurance agreements, and derivatives, and it influences perceived risk, pricing, and how cash flows are managed.

Tenor vs. Maturity

  • Tenor: the remaining time until a contract ends (declines over the life of the instrument).
  • Maturity: the original agreed-upon end date or total lifespan set when the instrument was issued (remains constant).
  • Example: A 10-year bond issued five years ago has a maturity of 10 years and a tenor of five years.

How Tenor Affects Risk and Pricing

  • Longer tenors usually carry higher risk because there is more time for market conditions, credit quality, or underlying values to change.
  • Investors generally demand compensation for longer tenors in the form of higher yields or lower prices.
  • Shorter tenors are typically seen as less risky and more liquid.
  • Firms often limit acceptable tenor based on counterparty creditworthiness and liquidity needs.

Tenor in Different Financial Contracts

  • Loans and Banking: Tenor refers to the repayment period for a borrower. Mortgage and consumer loan tenors commonly range from 5 to 25 years; some loans may extend up to about 30 years depending on the project and repayment capacity.
  • Derivatives: Tenor describes how long the derivative contract remains in effect. Longer-tenor derivatives are more sensitive to market movements.
  • Credit Default Swaps (CDS): Tenor must match the maturity of the underlying asset for the contract to function correctly; mismatches can disrupt cash flow coordination and valuation.

Tenor Basis Risk

Tenor basis risk arises when two otherwise similar instruments (same repricing date, currency, and benchmark) re-price or behave differently because they cover different periods or tenors. This can create unintended exposure when hedging or swapping cash flows between instruments with different tenors.

Practical Considerations When Assessing Tenor

  • Match tenor to cash-flow needs and asset/liability timing.
  • Adjust tenor limits based on counterparty credit ratings.
  • Consider liquidity: shorter tenors generally enhance flexibility.
  • Account for hedging and basis risk when aligning tenors across instruments.
  • Regulatory and capital requirements may influence acceptable tenors for financial institutions.

Real-World Example

A corporate CFO managing working capital may hold short- and medium-term securities with tenors of one to five years. Securities bought three years ago with five-year original maturities now have two years of tenor remaining. The CFO may permit longer tenors for highly rated counterparties while restricting weaker counterparties to shorter tenors to limit credit exposure.

Key Takeaways

  • Tenor is the remaining life of a financial contract and is distinct from maturity.
  • Longer tenors generally increase risk and require higher compensation.
  • Proper tenor matching is crucial for derivatives, CDS, and effective cash-flow management.
  • Loan tenors commonly range from 5 to 25 years, with some exceptions up to around 30 years.
  • Be mindful of tenor basis risk when hedging or structuring contracts.