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Chapter 16 — How do Bonds Work?
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How do Bonds Work?

A bond has a par value which is almost always $1000; $1000 = 1 bond. The par value is the face value of the bond and bonds are usually traded in bunches (i.e. 10 bonds would be a $10,000 investment). The bonds pay a fixed interest rate on a fixed schedule. Bonds pay the interest gained as a coupon payment in cash according to the rate and type of bond. Coupons can be paid annually, semi-annually, or in other increments as determined by the bond issuer.

Upon maturity (the last payment of the bond), the par value is also returned. The actual purchase price of the bond is rarely exactly the $1000 par value or face value of the bond. Bonds sold in the secondary market can be purchased at different levels of maturity and they can be purchased at a premium or at a discount depending on the expected return of a bond. For example, a bond is sold for $1200 would be said to be selling at a premium and a bond being sold for $800 would be said to be selling at a discount (when par value is $1000).

If a bond is selling at a premium, its real value will naturally decline as it gets closer to the maturity date and if interest rates increase, par value will never change. It is important to keep in mind the time sensitive and interest rate sensitive nature of bonds when evaluating their potential return.

Quiz

A bond with a par value of $1000 is selling at $1100. This could be because of which of the following reasons?

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0/76 (0%) Correct
  • 1
    The bonds value to the investor exceeds the par value
  • 2
    The bond has several coupon payments left to pay that create actual value of the bond that is greater than par value.
  • 3
    It is selling during a period of low interest rates.
  • 4
    All of the above.
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