When bonds are issued, they are usually sold at their par value, which is also referred to as their face value. For most corporate bond issues, this par value is $1,000, while some of the government bonds can have a par value of $10,000. This is the principal amount of a bond and it is returned to the investors when the bond matures. However, during the term of a bond, market forces make the value of the bond change. At any time, the bond could be selling at a value higher than its par, lower than its par or at its par value.
- Inverse Relationship with Interest Rates: Bond prices have an inverse relationship with interest rates. When interest rates in the economy go up (all other things being equal), bond prices go down, and vice versa. It is easy to understand why this happens.
Let’s say you have invested in a plain vanilla bond at a par value of $1,000 and a coupon rate of 5%. When interest rates in the economy go up, future bond issues will have to pay a higher coupon rate, let’s say 6%. In such a scenario, an investor will be willing to buy your bond from you only if you sell it at a value lower than its par such that the buyer is compensated for the lower interest payments.
The opposite of this happens when interest rates go down. Now future bonds will be issued at a lower interest rate and buyers will be willing to pay you more as your bond offers higher interest earnings. This will increase the price of the bond in the market.
- Impact of Creditworthiness:
Another reason that can have a huge effect on bond prices is a change in the creditworthiness of the issuer. For example, if a company is facing financial difficulties that can adversely impact its ability to repay its obligations, credit rating agencies can decide to lower its credit rating.When that happens, markets will react by lowering the prices of bonds issued by the company as there is now a much greater risk of default associated with those bonds. The same thing can happen to countries ,to see the prices of bonds issued by a national government change drastically in response to bad economic data,as the risk is high ,it makes the bond price go down and the demand for high yield go up.
When a bond is selling at par value, it’s price is listed as 100.When it is selling at a 10% discount, its price is listed at 90. Let’s say when it’s selling at a 5% premium, its price is listed as 105,the bond listed as 105 and having a par value of $1,000 can be calculated as 105% of $1,000, which comes to $1050.