If you’re an equity investor, you buy stocks at the current market price and hope they appreciate. For debt investors, it’s the opposite concept. Investors buy bonds based on their face value: the amount of money the bond will be worth at maturity. In other words, it’s the contractual amount that is to be repaid to the lender. It’s also known as par value.
Face value is one of the biggest advantages of investing in debt securities: you know exactly how much you’re entitled to when an investment fully matures. It’s why many investors buy bonds, and even more trade them. Face value plays a big role in not only the future value of the bond, but the demand for it right now.
Here’s a look at why bond face value is important and what it means in the context of debt securities.
Bond Face Value is Not Market Value
Investors can encounter bonds in two ways: from primary issuers and through secondary markets. This is an important distinction when it comes to bond value. There’s a difference between face value and market value.
- Face value is the original price of the bond, set by the lender, repaid at maturity.
- Market value is the price a bond trades at in secondary markets, above or below par.
There’s no discrepancy when buying bonds at face value—the par value represents the initial investment. If you decide to buy or sell a bond on the secondary market, other market forces dictate demand and the price other investors are willing to pay for it.
Bonds Trade Above or Below Par Value
When they reach the secondary market, bonds often trade at rates above or below face value. This depends on two things: the bond’s coupon rate and current interest rates.
- If current interest rates are lower than the bond’s coupon rate, the bond will trade at a premium, above its par value.
- If current interest rates are higher than the bond’s coupon rate, the bond will trade at a discount, below its par value.
Keep in mind that the par value of the bond generally remains static—interest rates are the dynamic variable. While the face value of the bond offers a promise of total repayment, interest rates are the real driver behind their value in secondary markets.
It’s also worth noting zero-coupon bonds here. Since these bonds don’t pay interest, they almost always trade below par value in secondary markets.
An Example of Bond Value
ABC Company decides to issue a $5 million public bond, in the form of 5,000 bonds worth $1,000. Joe Smith purchases a bond at par value for $1,000, with a coupon rate of 2.5%. It has a maturity date of 10 years. Two years in, Joe decides to sell the bond. Interest rates are at 3%, so the bond sells for a discounted market value of $970.
The Type of Bond Matters
The face value of a bond depends on the type of bond. Most AAA bonds—high quality corporate bonds—come in denominations of $1,000. Other bonds such as Treasuries and municipal bonds come in increments ranging from $100 to $10,000. There are also U.S. Savings Bonds (Series E, Series EE and Series I), available in much lower denominations. The latter aren’t typically considered investment products.
The type of bond matters not only for the face value, but for coupon rate and risk. Specifically, coupon and risk tend to balance each other. A $1,000 high-quality AAA corporate savings bond may carry a 3% interest rate, while a $1,000 lower-quality BBB bond may carry an interest rate of 6% to make up for its poorer quality rating. All of this plays a role in the desirability of a bond in the secondary market, which affects market price vs. par value.
Other Important Bond Investing Terms
Understanding face value and the way it dictates a bond investment is more easily understood in the context of other bond investing terms. Here are some of the most important concepts that play a role in bond investments:
- Par value. Also called face value or principal, it’s the bond repayment amount.
- Coupon rate. The interest rate that dictates the amount of payments to the bond holder.
- Maturity date. The date when the principal amount of the bond gets repaid.
- Term. The time from bond issuance to maturity, or the number of interest payments.
- Yield to maturity. The annualized return on the investment in the bond.
- Market value. The amount a bond trades for in relation to its par value.
One other term to remember: default. If the bond issuer defaults on the bond, bond holders won’t see the face value repaid. This effectively renders the bond worthless, which makes it even more important to check the creditworthiness of the issuer and the rating of the bond.
Bond Face Value is Important, But Not Paramount
Investors in debt securities will quickly come to learn the importance of a bond’s face value vs. its market value. More importantly, they’ll also learn that par value isn’t the only governing factor in a bond investment. The coupon rate and creditworthiness of the issuer play a major role in the significance of the investment, as well as affect its market rate.
However, did you know that investing in bonds is a popular strategy for investors who are preparing for retirement? to learn more, sign up for the Wealthy Retirement e-letter below!
At the end of the bond’s term, face value becomes important—it’s the amount investors will receive as the investment culminates. It provides a level of certainty that’s well worth the wait for risk-averse investors.