Understanding How At Par Works, With Examples
[ad_1]
What Is at Par?
The term “at par” means at face value. A bond, preferred stock, or other debt instrument may trade at par, below par, or above par.
Par value is static, unlike market value, which fluctuates with credit ratings, time to maturity, and interest rate fluctuations. The par value is assigned at the time the security is issued. When securities were issued in paper form, the par value was printed on the face of the security, hence the term “face value.”
Key Takeaways
- Par value is the price at which a bond was issued, also known as its face value.
- A bond’s price will then fluctuate based on prevailing interest rates, time to maturity, and credit ratings, causing the bond to trade either at above par or below par.
- “At par” will always refer to the original price that a bond was issued at.
- The owner of a bond will receive its par value at its maturity date.
Understanding at Par
Due to the constant fluctuations of interest rates, bonds and other financial instruments almost never trade exactly at par. A bond will not trade at par if current interest rates are above or below the bond’s coupon rate, which is the interest rate that it yields.
A bond that was trading at par would be quoted at 100, meaning that it traded at 100% of its par value. A quote of 99 would mean that it is trading at 99% of its face value.
Par value for common stock exists in an anachronistic form. In its charter, the company promises not to sell its stock at lower than par value. The shares are then issued with a par value of one penny. This has no effect on the stock’s actual value in the markets.
A New Bond
If, when a company issues a new bond, it receives the face value of the security, the bond is said to have been issued at par. If the issuer receives less than the face value for the security, it is issued at a discount. If the issuer receives more than the face value for the security, it is issued at a premium.
The yield for bonds and the dividend rate for preferred stocks have a material effect on whether new issues of these securities are issued at par, at a discount, or at a premium.
A bond that trades at par has a yield equal to its coupon. Investors expect a return equal to the coupon for the risk of lending to the bond issuer.
Example of at Par
If a company issues a bond with a 5% coupon, but prevailing yields for similar bonds are 10%, investors will pay less than par for the bond to compensate for the difference in rates. The bond’s value at its maturity plus its yield up to that time must be at least 10% to attract a buyer.
If prevailing yields are lower, say 3%, an investor is willing to pay more than par for that 5% bond. The investor will receive the coupon but have to pay more for it due to the lower prevailing yields.
What Is a Bond’s Par Value?
A bond’s par value is its face value, the price that it was issued at. Most bonds are issued with a par value of $1,000 or $100. Over time, the bond’s price will change, due to changes in interest rates, credit ratings, and time to maturity. When this happens, a bond’s price will either be above its par value (above par) or below its par value (below par).
Are Bonds Always Issued at Par Value?
No, bonds are not always issued at par value. They can be issued at a premium (price is higher than the par value) or at a discount (price is below the par value). The reason for a bond being issued at a price that is different than its par value has to do with current market interest rates. For example, if a bond’s yield is higher than market rates, then a bond will trade at a premium. Conversely, if a bond’s yield is below market rates, then it will trade at a discount to make it more attractive.
What Is a Bond’s Coupon Rate?
The coupon rate of a bond is the stated amount of interest that the bond will pay an investor at the time of its issue. A bond’s coupon rate is different from a bond’s yield. A bond’s yield is its effective rate of return when the bond’s price changes. A bond’s yield is calculated as coupon rate / current bond price.
[ad_2]
Source link