What Is Dollar Price?
If that bond is later sold to someone else on the secondary market before maturity then the price of the bond will likely differ from its face value and be quoted as a percentage of par. Dollar price is one of two ways that a bond price can be quoted, the other is by its yield.
- Dollar Price refers to the price paid for a bond.
- It is typically expressed as a percentage of the par value of a bond.
- As the bond trades, its dollar price fluctuates in the secondary market.
Understanding Dollar Price
Bonds are used by companies, municipalities, states, and U.S. and foreign governments to finance a variety of projects and activities. For example, a municipal government may issue bonds to fund the construction of a school. A corporation, on the other hand, might issue a bond to expand its business into a new territory.
The price of a bond can be quoted in one of two ways by the various exchanges: by dollar price and by yield. Frequently, providers of bond quotes publish both the dollar price and yield concurrently. A bond's yield indicates the annual return until the bond matures.
A bond that is selling at par (at its face value) would be quoted at 100 in terms of dollar price. A bond that is trading at a premium will have a price greater than 100; a bond that is traded at a discount will have a price that is less than 100.
As the price of a bond increases, its yield decreases. Conversely, as bond prices decrease, yields increase. In other words, the price of the bond and its yield are inversely related.
Bond Yield Vs. Dollar Price
As bonds' dollar prices increase, their yields fall -- and vice-versa. For example, assume an investor purchases a bond that matures in five years with a 10% annual coupon rate and a face value of $1,000. Each year, the bond pays 10%, or $100, in interest. Its coupon rate is the interest divided by its par value.
If interest rates rise above 10%, the bond's price will fall if the investor decides to sell it. For example, imagine interest rates for similar investments rise to 12.5%. The original bond still only makes a coupon payment of $100, which would be unattractive to investors who can buy bonds that pay $125 now that interest rates are higher.
If the original bond owner wants to sell the bond, the price can be lowered so that the coupon payments and maturity value equal yield of 12%. In this case, that means the investor would drop the price of the bond to $927.90. In order to fully understand why that is the value of the bond, you need to understand a little more about how the time value of money is used in bond pricing, which is discussed later in this article.
If interest rates were to fall in value, the bond's price would rise because its coupon payment is more attractive. For example, if interest rates fell to 7.5% for similar investments, the bond seller could sell the bond for $1,101.15. The further rates fall, the higher the bond's price will rise, and the same is true in reverse when interest rates rise.
In either scenario, the coupon rate no longer has any meaning for a new investor.
For example, say an investor purchases a bond with a 10% coupon and $1,000 par value. At issue, the dollar price is $1,000.
If the bond's market value increases to $1,120 its dollar price would be quoted at 112%. If the investor were to sell, they could make $120 profit from the trade, in addition to whatever interest they had collected on the bond to that point.