What is the par value of bonds, you ask?
Investing doesn’t have to be complicated. So, let’s break down the concept of par value of bonds so anyone can understand.
Imagine you’re lending money to a company or government, and they promise to pay you back with interest.
That’s the essence of a bond. Here’s what you need to know in plain language.
What you'll learn:
➤ What’s a Bond?
A bond is like an IOU. It’s issued by companies, governments, or their agencies when they need money. When you buy a bond, you’re basically lending them money. In return, they owe you the bond’s ‘par value’ and interest when the bond matures (that’s when it’s due).
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Basic Bond Terms
Maturity Date: This is the day when the bond’s principal (the initial amount you lent) is supposed to be paid back. It can be a short or long time from when you bought it.
Coupon Rate/Discount Rate: This is like the ‘interest rate’ on the bond. It’s a fixed percentage of the bond’s par value. You get these interest payments regularly, like once a year or every six months.
➤ What’s the Par Value of Bonds?
The ‘par value’ is the amount written on the bond itself. It’s the money the issuer promises to pay you back when the bond matures.
Unlike the ‘market value,’ which can change, the par value stays the same. Par value is important because it tells you the bond’s maturity value and the value of the interest payments you’ll receive.
Par Value vs Market Value
Par Value: This is set when the bond is issued and doesn’t change.
Market Value: It’s the current price of the bond if you want to sell it. It goes up and down as people buy and sell bonds. If a bond sells for more than its par value, it’s at a ‘premium.’ If it sells for less, it’s at a ‘discount.’
➤ Interest Rates and Bond Value
Imagine you buy a $1,000 bond with a 5% coupon rate. That means you’ll get $50 each year in interest (5% of $1,000). But here’s the twist:
When Rates Match: If your bond’s interest rate (5%) matches the market interest rate (also 5%), it’s said to be ‘trading at par value.’
When Rates Rise: If market interest rates go up to 6%, your bond’s value drops because your 5% interest isn’t as good as the 6% others are getting.
When Rates Fall: If market interest rates fall to 4%, your bond becomes more attractive, and its value goes up.
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➤ Final thoughts
Par value is like the face value of a bond. It’s crucial because it defines how much you’ll get when the bond matures and the value of your interest payments. Understanding par value helps you decide whether to sell your bond or keep it until it matures.
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🔥 Daily Inspiration 🔥
〝Knowledge is power: you hear it all the time but knowledge is not power. It’s only potential power. It only becomes power when we apply it and use it. Somebody who reads a book and doesn’t apply it, they’re at no advantage over someone who’s illiterate. None of it works unless you work. We have to do our part. If knowing is half the battle, action is the second half of the battle.〞
― Jim Kwik
