Vinu: Hey Manu, I’ve been hearing a lot about terms like "average maturity" in the context of term loans. Can you explain what average maturity is and how it’s calculated?

Manu: Sure, Vinu! Average maturity is a measure of the average time it takes for the repayments of a term loan to be made. It gives you an idea of how long the loan will be outstanding before it’s fully repaid. The calculation is like a weighted average of the loan's maturity periods.

Vinu: How do you calculate it?

Manu: Let’s walk through an example. Say you have a term loan of ₹10 lakhs with a 5-year repayment schedule. The loan is repaid in equal annual installments of ₹2 lakhs each year.

List the installments and their respective periods:

Vinu: So, the average maturity is 3 years. But the loan term is 5 years. What does this really mean?

Manu: Good question! The average maturity of 3 years means that, on average, the loan will be repaid in 3 years. It doesn't change the fact that the loan term is 5 years, but it tells you when, on average, the repayments are expected to be made.

Vinu: Why is this important?

Manu: It helps both lenders and borrowers understand the timing of cash flows. If the average maturity is shorter, it means more of the principal is repaid earlier, reducing the outstanding balance faster. If the average maturity is longer, more of the principal is repaid later, meaning the loan balance stays higher for a longer time.

Vinu: I see. So, if the average maturity is 2 years in a 5-year loan, what does that indicate?

Manu: That would mean the repayments are front-loaded, with a significant portion of the principal being repaid in the first 2 years. The loan balance decreases faster, and the interest burden could be lower in the later years.

Vinu: And what if the average maturity is 4 years in a 5-year loan?

Manu: In that case, the repayments are back-loaded, meaning the bulk of the principal is repaid closer to the end of the term. The loan balance stays higher for longer, and the interest costs could be higher over the loan's life.

Vinu: So, understanding average maturity helps in planning cash flows and managing interest costs better?

Manu: Exactly! It gives a clearer picture of how the loan repayments are structured and their impact on finances over time.

Vinu: Thanks, Manu! This really helps me understand the concept of average maturity and how it affects a loan.

Manu: Anytime, Vinu! It’s always good to understand these financial concepts clearly.