A:

When you buy a bond, you are loaning money to the issuer. Because a bond is a loan, the interest paid to the bondholder is payment for lending the money. The interest payable is stated as a percentage of the amount borrowed, known as the par value of the bond. Thus, a bond with a par value of $1,000 and an interest rate of 10% promises to pay $100 per year in interest until the bond matures, at which point the original par value ($1,000) is returned to the bondholder.

Although a bond has a fixed par value, the prices at which it is bought and sold in the financial market may be either higher, lower or equal to par. For example, if the market interest rate is 10%, then a bond paying 10% interest will sell for par value. However, if the market interest rate rises to 11%, no one will pay par value because identical bonds that pay an 11% rate are available. This causes the price of the bond to fall until the interest payable plus the gain earned by the difference between par value and the lower price paid yields an 11% return.

For the same reason, when the market interest rate falls, bond prices increase. This scenario demonstrates the basic principal between interest rates and bond prices; when one goes up the other goes down. Because market interest rates fall and rise constantly, so do bond prices. However, the par value of a bond, the amount you will receive at maturity, will never change regardless of the market rate or bond price.

If the market interest rate is higher than the interest payable on a bond, the bond is said to be selling at a discount (below par value). If the market interest rate is lower than the interest payable on a bond, it is said to be selling at a premium (above par). And, if the market interest rate equals the interest payable, the bond will sell for par. The par value itself, and thus the value of a bond payable upon maturity, will never change, regardless of the bond price or market interest rates.

(For further reading on this subject, please see our Bond Basics Tutorial.)

RELATED FAQS
  1. Will the price of a premium bond be higher or lower than its par value?

    Find out why the selling price of a premium bond is always higher than its par value, including how changing interest rates ... 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. Can the marginal propensity to consume ever be negative?

    Find out when a bond's yield to maturity is equal to its coupon rate, and learn about the basic components of bonds and how ... Read Answer >>
  4. What is the difference between par value and market value?

    Learn about the difference between the par value and market value of financial securities, including the role they play in ... Read Answer >>
  5. How does the effective interest method treat the interest on a bond?

    Find out why you should look at the effective interest of a bond rather than simply relying on its stated coupon rate when ... Read Answer >>
  6. What happens to the price of a premium bond as it approaches maturity?

    Learn how bonds trade in regard to premiums and discounts, and how bond prices shift closer to par value as bonds approach ... Read Answer >>
Related Articles
  1. Markets

    Are Bonds Selling At A Premium A Good Investment?

    A bond with a par value – or face value -- of $1,000 is selling at a premium when its price exceeds par.
  2. Investing

    What is Par Value?

    Par value is a term used for investments that means original value. It’s also called face value or nominal value.
  3. Markets

    Why Would A Stock Have No Par Value?

    A stock with no par value might trade for thousands of dollars. It just depends on what the market deems it’s worth.
  4. Markets

    Understanding Bond Quotes

    A bond quote is a bond’s trading price.
  5. Markets

    Understanding Face Value

    Face value is the dollar value stated on a security.
  6. Managing Wealth

    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.
  7. Markets

    Explaining Original Issue Discount

    An original issue discount is the amount below par at which a bond or other debt instrument is issued.
  8. Trading

    Top 6 Uses For Bonds

    We break down the stodgy stereotype to see what these investments can do for you.
  9. Managing Wealth

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  10. Managing Wealth

    How Bond Prices and Yields Work

    Understanding bond prices and yields can help any investor in any market.
RELATED TERMS
  1. Par Value

    The face value of a bond. Par value for a share refers to the ...
  2. At Par

    A term that refers to a bond, preferred stock or other debt obligation ...
  3. Par

    Short for "par value," par can refer to bonds, preferred stock, ...
  4. Below Par

    A term describing a bond whose price is below the face value ...
  5. Dollar Price

    The percentage of par, or face value, at which a bond is quoted. ...
  6. Face Value

    The nominal value or dollar value of a security stated by the ...
Hot Definitions
  1. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  2. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  3. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  4. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  5. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
  6. Weighted Average Life - WAL

    The average number of years for which each dollar of unpaid principal on a loan or mortgage remains outstanding. Once calculated, ...
Trading Center