What Is a Par Bond and How Does It Work?

Bonds are financial instruments representing a loan made by an investor to a borrower. These securities promise to pay back the principal amount, known as the face value, at a specified future date, along with periodic interest payments. Understanding “par” is fundamental to how bonds are valued and traded.

Defining Par Value and Par Bonds

The par value of a bond, also known as its face value, represents the principal amount that the bond issuer promises to repay the bondholder at maturity. This amount is typically set at $1,000 for corporate bonds. The coupon rate, which determines the interest paid, is calculated as a percentage of this par value. For instance, a bond with a 5% coupon rate and a $1,000 par value would pay $50 in interest annually.

A par bond is a bond that is currently trading in the market at its par value. When a bond trades at par, its market price exactly equals the principal amount that will be returned to the investor at the bond’s maturity date.

How Market Interest Rates Affect Bond Prices

Bond prices in the secondary market move inversely to changes in prevailing market interest rates. When market interest rates rise, newly issued bonds offer higher coupon rates. This makes existing bonds with lower coupon rates less attractive, causing their market prices to fall below their par value, resulting in a discount bond. Conversely, when market interest rates fall, existing bonds with higher coupon rates become more appealing.

This drives their market prices above par, creating a premium bond. A par bond represents an equilibrium where the bond’s fixed coupon rate aligns precisely with the current market interest rates for similar-risk investments. Its coupon payments are competitive with what investors could earn elsewhere, leading its price to settle at its face value.

Key Characteristics of Par Bonds

When a bond trades at par, several key financial metrics align. For a par bond, the coupon rate, which is the stated interest rate paid by the issuer, is equal to the bond’s current yield. The current yield is calculated by dividing the annual coupon payment by the bond’s current market price. Since the market price of a par bond is equal to its par value, the current yield naturally matches the coupon rate.

Furthermore, for a bond trading at par, the yield to maturity (YTM) is also equal to both the coupon rate and the current yield. The YTM represents the total return an investor can expect to receive if they hold the bond until it matures, taking into account all coupon payments and the difference between the purchase price and the par value. When a bond is purchased at par, there is no capital gain or loss at maturity, simplifying the calculation of the total return. This equality across these yield measures is a defining characteristic of a par bond.

Investor Considerations for Par Bonds

For an investor, purchasing a bond at par offers a straightforward return expectation. If the bond is held until its maturity date, the investor can expect to receive the bond’s face value as the principal repayment. This means there is no capital gain or loss from the purchase price to the maturity value, unlike bonds bought at a discount or premium. The return on investment for a par bond held to maturity will primarily consist of the periodic coupon payments.

The yield to maturity for a bond purchased at par directly equals its coupon rate, simplifying the assessment of expected returns. This predictability can be appealing to investors seeking consistent income streams without the complexities of calculating capital gains or losses at maturity. While all bonds carry some risk, such as the issuer’s ability to make payments, the pricing of a par bond offers a clear understanding of the expected cash flows and final principal repayment.