How is face value affected when the price of a bond goes down?

0


When you buy a bond, you are lending money to the issuer. Since a bond is a loan, the interest paid to the holder of the bond is the payment for the loan of the money. Interest payable is expressed as a percentage of the amount borrowed, called the face value of the bond.

As a result, a bond with a face value of $ 1,000 and an interest rate of 10% promises to pay $ 100 in interest per year until the bond matures, when the bond expires. original face value ($ 1,000) is returned to the bond holder.

Key points to remember

  • Although a bond has a fixed face value, its price in the secondary market may be higher or lower than its face value.
  • In general, bond prices rise when interest rates fall. And bond prices fall as interest rates rise.
  • It’s important to note that a bond’s face value (the amount you’ll receive at maturity) will never change, regardless of secondary market prices.

What happens when interest rates rise (or fall)

Although a bond has a fixed face value, the prices at which it is bought and sold in the financial market can be above, below or equal to par. For example, if the market interest rate is 10%, a bond that pays 10% interest will sell for its face value. However, if the market interest rate rises to 11%, no one will pay the face value because identical bonds that pay an 11% rate are available.

This lowers the price of the bond until the interest payable plus the gain realized by the difference between the face value and the lower price paid yields a return of 11%.

For the same reason, when the market interest rate falls, bond prices rise. This scenario demonstrates the basic principle between interest rates and bond prices: when one goes up, the other goes down. Because market interest rates are constantly falling and rising, so are bond prices.

Does the face value change?

It is important to note that the face value of a bondthe amount you will receive at maturitywill 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 sell at a discount (below face value). If the market interest rate is lower than the interest payable on a bond, it is said to sell for a premium (above par).

And if the market interest rate equals the interest payable, the bond will sell at par. The face value itself, and therefore the value of a bond payable at maturity, will never change, regardless of the bond’s price or market interest rates.


Share.

Leave A Reply