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. What is a good debt ratio, and what is a bad debt ratio?

    Learn about the factors that influence how investors and lenders evaluate the debt ratio for a company and why the answer ... Read Answer >>
  2. What is a basis point (BPS)?

    A basis point is a unit of measure used in finance to describe the percentage change in the value or rate of a financial ... Read Answer >>
  3. Do hedge funds invest in bonds?

    Learn how hedge funds use bonds and other fixed income securities to generate significant, recurring returns for their shareholders. Read Answer >>
  4. Do mutual funds pay dividends or interest?

    Learn how and why mutual funds pay interest or dividends, including the different funds and which types generate each type ... Read Answer >>
  5. Can mutual funds only hold bonds?

    Find out which mutual funds include only bonds in their portfolios. Learn why some funds invest in different types of bonds ... Read Answer >>
  6. What are the risks of annuities in a recession?

    Distinguish between the most common types of annuities, and understand which types of annuities pose the most risk during ... Read Answer >>
Related Articles
  1. Chart Advisor

    Play the Rotation Out of High Yielders (XLU, TLT)

    The market may be at the cusp of a rotation out of high yielding instruments and into growth plays.
  2. Bonds & Fixed Income

    The Bond Investor's Challenge: Generating Yield in a Low Interest Environment

    Discover expert advice on how to generate higher yield in a bond portfolio in 2016, despite the global challenges of low rates and high debts.
  3. Investing News

    Money Market vs. Short-Term Bonds: A Compare and Contrast Case Study

    Discover characteristics of money market and short-term bonds, including how the investments are alike and different, and the benefits and risks each offers.
  4. Investing News

    Performance Review - U.S. Fixed Income in 2015

    Review the performance of the U.S. fixed-income securities in 2015, from the relatively strong U.S. municipal bond market to the calamitous high-yield space.
  5. Bonds & Fixed Income

    Do Long-Term Bonds Have A Greater Interest Rate Risk Than Short-Term Bonds?

    The answer is yes, and there are two main reasons why.
  6. Bonds & Fixed Income

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  7. Investing

    What Happens to Bond ETFs in Stressed Markets?

    We are going to dive a little deeper today at how bond exchange traded funds (ETFs) fare when the markets are stressed.
  8. Investing

    One Market Where Oil Doesn’t Really Matter Much

    If you are getting worried that your portfolio will be affected by the recent slide in oil and energy prices, keep reading.
  9. Investing News

    PIMCO Report: Credit Selection Key to High Yield

    Read and Summarize The Report That I provided "PIMCO High Yield Municipal Bond Fund - Credit Selection Key to Outperformance". No tickers in the title are necessary.
  10. Stock Analysis

    The 6 Most Liquid Muni Bond ETFs (MUB,SHM,TFI,ITM)

    Looking for safety in an uncertain world? Consider these liquid muni bond ETFs.
RELATED TERMS
  1. Negative Interest Rate Environment

    A negative interest rate environment exists when a central bank ...
  2. Social Impact Bond - SIB

    A contract with the public sector or governing authority, whereby ...
  3. Impact Investing

    Investing that aims to generate specific beneficial social or ...
  4. Sovereign Bond Yield

    Sovereign bond yield is the interest rate paid on a government ...
  5. Negative Bond Yield

    A negative bond yield is an unusual situation in which issuers ...
  6. Extreme Mortality Bond - EMB

    Investopedia defines extreme mortality bond (EMB).

You May Also Like

Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  3. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  4. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
  5. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  6. Economies Of Scale

    Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because ...
Trading Center