What it means
Par value, also called face value, is the fixed sum printed on the bond that the issuer repays on the maturity date. Bond prices are quoted as a percentage of par, so a price of 92 means 92% of face value.
Anything under 100 is below par, anything above is at a premium, and exactly 100 is at par. The most common cause is a move in market interest rates.
A bond paying a fixed 4% coupon becomes less attractive when newly issued bonds of similar quality pay 6%, so its price falls until the effective return to a new buyer matches what the market offers. The mechanism is arithmetic rather than sentiment: the coupon cannot change, so the price must.
The second cause is credit risk. If investors start to doubt the issuer will pay, they demand a larger discount as compensation, which is why the bonds of a struggling borrower can trade at 70 or 60 without any change in interest rates at all.
Separating a rate-driven discount from a credit-driven one matters, because the first normally reverses as the bond approaches maturity and the second may not. For a buyer, below par has a useful feature.
The discount becomes a gain if the bond is held to maturity and repaid in full, and that gain forms part of the yield to maturity, which combines coupon income with the pull of the price back towards par over time. The phrase also appears in ordinary speech, loosely meaning below the expected standard.
In a finance conversation, though, treat it as a precise statement about a security's price, and ask which of the two causes is driving it before drawing any conclusion about the issuer.
In practice
Real-world examples.
Example
A pension fund holds a batch of ten-year government bonds bought at par with a 2% coupon. After two years of rate rises the same bonds are quoted at 87, well below par, and the fund reports an unrealised loss even though it fully expects to be repaid in full at maturity.
Example
A regional utility issues bonds that trade at 98 immediately after a credit rating downgrade. The discount reflects a modest increase in perceived default risk rather than any change in the wider interest rate environment.
Example
A corporate treasurer buys back the company's own bonds in the open market at 91 rather than waiting for maturity. Retiring $10,000,000 of face value costs $9,100,000, so the company books a $900,000 gain on early extinguishment of debt.
Formula
Calculation
Price as a percentage of par = (Market Price / Par Value) x 100
Discount = Par Value - Market Price
Current Yield = Annual Coupon Payment / Market Price
Worked example. A corporate bond has a par value of $1,000 and pays a fixed coupon of 4%, which is $40 a year. Market rates for similar bonds have risen, and this bond now trades at $920.
Price as a percentage of par = ($920 / $1,000) x 100 = 92
The bond is quoted at 92 and is therefore below par.
Discount = $1,000 - $920 = $80 per bond, an 8% discount to face value
Current Yield = $40 / $920 = 4.35%, higher than the 4% coupon rate
An investor buying 500 of these bonds pays 500 x $920 = $460,000 for holdings that will repay 500 x $1,000 = $500,000 at maturity. That is a $40,000 gain on redemption, on top of the $20,000 of coupon income received each year across the whole holding.Case study
Seen in the real world.
Coastvale Water Company is a fictional utility used here as an illustrative example. Five years ago it issued $50,000,000 of ten-year bonds at par with a 3.5% coupon, when comparable borrowing costs were around the same level.
Interest rates then rose steadily, and by year five new issues of similar quality were paying about 6%. Coastvale's bonds drifted down to a quoted price of 89, firmly below par. Several board members read the price as a verdict on the company's health, which prompted an anxious discussion about whether the market had lost confidence in the business.
The finance director walked the board through the arithmetic. Coastvale's credit rating was unchanged, its interest cover had actually improved, and the discount was entirely explained by the gap between its fixed 3.5% coupon and current market rates. The illustrative lesson is that a bond trading below par tells you something about the market, the issuer, or both, and the first job is always to work out which.
Watch out
Common mistakes.
- Reading a below par price as automatic evidence that the issuer is in trouble, when a rate move alone explains most discounts.
- Assuming the issuer pays back the discounted price, when in fact it repays the full par value at maturity.
- Comparing current yield with the coupon rate and stopping there, rather than calculating yield to maturity, which also captures the pull back towards par.
Questions
People also ask.
What does a bond quoted at 92 mean?
It means the bond trades at 92% of its face value, so a $1,000 bond costs $920.
Is buying below par always a bargain?
No, because the discount may be compensating you for genuine default risk rather than simply reflecting higher market interest rates.
Do all bonds return to par?
Bonds that are repaid in full converge on par as maturity approaches, but a bond that defaults never gets there.
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