We all know how this one feels on the course, but that's not what we're going for here. When you buy a bond, it has a face value: that's the set price of the bond when it was issued. That bond will pay interest each year. Bonds trade like stocks, more or less and sometimes, the actual trading value of the bond goes up because investors are willing to pay more than the face value or par value of the bond. Why would they do that? Well, if overall interest rates have dropped, then bonds with coupon rates paying higher interest levels will be bid up. When this happens, your bond can be bid up to be selling above par.
Example: Galactic Empire incorporates and decides to issue bonds because they're in debt after building a new space station. Darth Vader decides he wants to buy a $1,000 bond. He's getting up there in years and wants to be able to enjoy his days in retirement at some point. He gets himself a 5-year bond with a 10% coupon. That means that, every year, he'll get $100 for handing over his cash, and at the end of five years, he’ll get his original $1,000 back. After two years, Darth is dreaming about what he'll do with that money if there's a disturbance in the Force. Interest rates drop. Now the same type of bond from the Empire comes with a 6% coupon because of the change. Good ol' Darth is feeling pretty smug because his bond 10% interest or $100 a year is locked in, but what happens to anyone who wants to invest now?
Related or Semi-related Video
Finance: What are Above Par and At Par?8 Views
Finance- a la shmoop....What are above par below par and at par...First what is [Man discussing at par on a golf course]
at par and yeah this may be not enough to make the tour but not too shabby but
what about in the finance world if a bond or other dead or preferred stock is
trading at par or at a hundred it's trading at face value and investors
buying the bond expect to get a return that matches the bonds coupon or [Dollar bills falling]
interest or distribution rate at par bonds are rare though most trade either
above or below par well when interest rates drop investors are willing to pay
more for older bonds with higher coupons and bonds will then trade above par when
interest rates increase while those lower interest rates look about as [Interest rates go up on a see-saw]
appealing as mold on your roast beef sandwich and bonds will trade below par
for less than the face value well interest rates aren't the only things
that effect a bonds ability to trade at par by the way company news can affect
it as well like if an alien spaceship attacks your factories and kidnaps your [Alien spaceship shoots factory and explosion occurs]
staff well your bonds value likely will decrease so let's say a bond yields 7%
meaning that for each thousand bucks you get 35 dollars paid to you twice a year
well this bond was issued eight years ago and now similar risk bonds have gone
way up in price and yields have gone way down so this bond might be quoted at 110
meaning that you pay eleven hundred dollars for that same sheet of paper
today so that your yield is not in fact 7% but rather 10 percent less than 7%
because you've paid and percent more for the bond that is you paid 10% over par
that new yield is 6.3% you paid 10 points over par for
the same 35 bucks twice a year that you're getting so that's above par below
par and at par if you're ever more than 30 above par well there's probably at [golf club stuck in a tree]
least one club stuck in a tree somewhere or swimming in a lake
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