Bonds are debt instruments issued by governments and corporations. The three key components of a bond are interest rate, maturity and face value. The face value is the contractual amount that is to be repaid at maturity. Most bonds are issued in $1,000 denominations, with $1,000 being the face value. Face value, or par, is important, because it is used to calculate or express other bond values and parameters.
Bond Interest Rates
The annual interest rate a bond pays is expressed as a percentage of par, or face value, at issuance. For example, an 8 percent bond will pay 8 percent interest, or $80, for each $1,000 of face value. This "official," or nominal, interest rate is called the coupon rate. However, once the bond is issued, the payment is set in dollars, in this case $80, and does not change.
Bond Maturity Payoff
A bond "matures" when it reaches its full face value. At maturity, the bond investor is to be repaid the full face value, regardless of how much he paid for the bond. The closer a bond moves toward its maturity date, the closer it also moves toward its full face value.
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How Bonds are Priced
Once issued, bonds can trade in the secondary market for more or less than the face value — at a premium or at a discount. Bonds are priced as a percentage of par, or face value. A price of 100 means 100 percent of the $1,000 face value, or $1,000. A price of 97.3 means $973 for each $1,000 of face value.
Different Bond Denominations
When an investor says that he wants to buy five bonds, he means five $1,000 face value bonds, or $5,000 worth of a particular bond. If the price of the bond is 97.3, he will end up paying $4,865 for $5,000 face value bonds. At maturity, he will get back $5,000 and realize a $135 capital gain on his investment, in addition to the annual interest he will have received.
Bond Yields Vs. Coupon Rates
The confusing part is the current yield vs. the coupon rate. The investor will collect $80 in interest annually, which on a $1,000 face value amounts to 8 percent — the "official" coupon rate. But if he paid $973 per $1,000, his annual yield, or return on his investment, would be $80 divided by $973, which is 8.2 percent.