Question

What does par value represent to the issuer of a bond?

Short answer

Par value is the issuer's promise to repay a bond at maturity and determines coupon payments.

Step-by-step solution

Understanding Par Value

Par value, also known as face value, is the amount that the issuer agrees to repay the bondholder at the maturity date. It is the minimum amount that the issuer guarantees to pay back regardless of market conditions.

Relation to Coupon Payments

The bond's coupon payments, which are periodic interest payments made to the bondholder, are typically calculated based on the par value. The fixed interest rate is applied to the par value to determine the amount of these payments.

Issuer's Liability

From the issuer's perspective, par value represents the liability they must fulfill upon the bond's maturity. It is the principal amount that the issuer is obligated to pay back to investors.

Key concepts

Bond Issuer

The bond issuer is the entity that creates and sells the bond in order to raise funds. They could be government entities, corporations, or municipalities. Think of the issuer as someone borrowing money. They issue the bond as a form of a loan, where they promise to pay back the initial amount, or par value, along with periodic interest payments. For the issuer, this serves as a relatively predictable way to obtain the necessary funds without diluting ownership or control, which might happen if they issued stock instead.

For the issuer, the par value of the bond directly represents a legal promise to pay the bondholder. The issuer is committed to pay the par value of the bond at the maturity date. This means when the bond reaches its maturity, the issuer will have to pay back the full par value to the investors. This forms the core obligation of the bond issuer towards the bondholder.

Coupon Payments

Coupon payments refer to the regular interest payments that are paid to the bondholder during the life of the bond. They are typically paid annually or semi-annually, offering a steady stream of income to the investors until the bond matures. These payments are calculated as a percentage of the par value. For instance, if a bond with a par value of $1,000 has a 5% coupon rate, the issuer pays $50 annually in coupon payments.

• These payments are vital because they represent the bondholder's return on investment over its term.
• They provide income predictability, appealing to those who seek steady cash flow.
• The regularity of these payments makes bonds known for their relatively low risk compared to stocks, which do not guarantee returns.

The issuer is responsible for making these payments on schedule. Missing a coupon payment could severely impact the issuer's credit rating.

Maturity Date

The maturity date of a bond is the day when the bond issuer is obligated to repay the bond's par value to the bondholder. This date is predetermined at the time the bond is issued and can range from a few months to several years, depending on the bond type. Upon reaching maturity, the bondholder will receive the last coupon payment, as well as the repayment of the principal.

Some key aspects of maturity date include:

• It marks the end of the bond's life cycle, concluding the contractual obligation between issuer and bondholder.
• The bond’s interest risk is closely tied to this date, as bonds with longer maturity periods are usually more sensitive to interest rate changes.
• It provides a timeline for the issuer to plan the repayment of funds, accommodating their financial strategy.

The anticipation of this date implies that both the issuer and bondholder can plan their financial moves around it, ensuring a smooth financial transaction conclusion.