Why Must a Bond Reach Par Value at Maturity?

Bond Pricing

• Bonds are typically issued in $1,000 denominations. An investor who buys one bond buys $1,000 worth of issuer's debt. The $1,000 is the par, or face value, which will be returned to the investor at maturity. After a bond is issued, its price can fluctuate in the secondary market. It can trade for more than the face value -- at a premium, or less than the face value -- at a discount. Whether an investor buys a bond at a premium or at a discount, he will get back the full face value at maturity.
  
  

Effect of Interest Rate Changes on Bond Prices

• Bond prices rise when interest rates fall and vice versa. This is because the interest, expressed as a percentage of par at issuance, is fixed until maturity in dollars. A 5 percent 10-year bond will pay $50 annually for each $1,000 of face value. If interest rates fall, new bonds may be issued with 4 percent interest -- that is, pay $40 annually for each $1,000 of face value. Since the old bonds are still paying $50, their price would be adjusted to yield the same 4 percent -- that is, they will trade at $1,250 per $1,000 of face value. If interest rates rise, new bonds may be issued with 6 percent interest -- that is, pay $60 annually for each $1,000 of face value. The old 5 percent bond will priced at $833 to yield 6 percent.
  
  

Bonds Approaching Maturity

• Bond buyers are willing to pay a premium as long as the yield they get is the highest they can find. Bond sellers are willing to accept a discount if they must sell. But as a bond approaches maturity, buyers are reluctant to pay more than the par value and sellers are reluctant to accept less than the par value because they know that at maturity they will receive the par value. In the example, investors who paid $1,250 and those who paid $833 for the 5 percent bond will both receive $1,000 at maturity.
  
  

Bond Trading And Pricing

• Bonds in the secondary market are priced to take the above into account. The longer a bond has until maturity, the more its price is determined by the prevailing interest rates; but the closer it gets to maturity, the closer its price gets to the par value -- regardless of the prevailing interest rates.