A:

There are two primary reasons a bond might be worth less than its listed face value. A savings bond, for example, is sold at a discount to its face value and steadily appreciates in price as the bond approaches its maturity date. Upon maturity, the bond is redeemed for the full face value. Other types of tradeable bonds are sold on the secondary market, and their valuations depend on the relationship between yields and interest rates, among other factors.

All bonds are redeemed at face value when they reach maturity unless there is a default by the issuer. Many bonds pay interest to the bondholder at specific intervals between the date of purchase and the date of maturity. However, certain bonds do not provide the owner with periodic interest payments. Instead, these bonds are sold at a discount to their face values, and they become more and more valuable until they reach maturity.

Not all bondholders hold onto their bonds until maturity. In the secondary market, bond prices can fluctuate dramatically. Bonds compete with all other interest-bearing investments. The market price of a bond is influenced by investor demand, the timing of interest payments, the quality of the bond issuer, and any differences between the bond's current yield and other returns in the market.

For instance, consider a $1,000 bond that has a 5% coupon. Its current yield is 5%, or $50 / $1000. If the market interest rate paid on other comparable investments is 6%, no one is going to purchase the bond at $1,000 and earn a lower return for his or her money. The price of the bond then drops on the open market. Given a 6% market interest rate, the bond ends up being priced at $833.33. The coupon is still $50, but the yield for the bond is 6% ($50 / $833.33).

RELATED FAQS
  1. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... Read Answer >>
  2. How does face value differ from the price of a bond?

    Discover how bonds are traded as investment securities and understand the various terms used in bond trading, including par ... Read Answer >>
  3. Should investors focus more on the current yield or face value of a bond?

    Find out when investors should focus on a bond's current yield versus its face value, including an example of how current ... Read Answer >>
  4. What causes a bond's price to rise?

    Learn about factors that influence the price of a bond, such as interest rate changes, credit rating, yield and overall market ... Read Answer >>
  5. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
Related Articles
  1. Investing

    How To Evaluate Bond Performance

    Learn about how investors should evaluate bond performance. See how the maturity of a bond can impact its exposure to interest rate risk.
  2. Investing

    An Introduction to Individual Bonds

    Individual bonds are better than bond funds and can be a key component to one’s investment strategy.
  3. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  4. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  5. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  6. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  7. Financial Advisor

    Simple Math for Fixed-Coupon Corporate Bonds

    A guide to help to understand the simple math behind fixed-coupon corporate bonds.
RELATED TERMS
  1. Bond

    A debt investment in which an investor loans money to an entity ...
  2. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  3. Bond Yield

    The amount of return an investor will realize on a bond. Several ...
  4. Bond Discount

    The amount by which the market price of a bond is lower than ...
  5. Bond Ladder

    A portfolio of fixed-income securities in which each security ...
  6. Term Bond

    Bonds from the same issue that share the same maturity dates. ...
Hot Definitions
  1. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  2. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  3. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  4. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  5. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  6. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
Trading Center