The fixed value assigned to bonds or stock
In short:
Par value is the nominal fixed value assigned to a bond or share of stock when they are initially issued. This price represents the minimum value of the bond or share of stock in the eyes of the issuing company. In the case of bonds, the par value represents the promised amount to be returned to the bondholder at expiration of the bond. With stock, however, the relevance of par value is extremely minimal.
Key Points
- Par value is the nominal fixed value assigned to a bond or share of stock when they are initially issued.
- Par value represents the promised amount by the issuing company to be returned to bondholders.
- In stock, par value has minimal relevance and is not an indication of true value.
In-depth:
Usefulness of Par Value
The usefulness of par value depends on what type of financing instrument par value is being assigned to, with the main two categories being bonds (debt) and stock (equity).
With bonds, par value acts as a fundamental factor since it is used to define the promised amount the bond issuing company promises to repay the bondholder at expiration. Additionally, for coupon bonds, bonds that make periodic payments, the par value is used to determine the actual cash amount which will be paid in each coupon. From this coupon amount, the coupon rate can be calculated.
Additionally, once the par value of a bond is set, investors can easily identify if the bond is trading above or below par when making an investment decision. This will affect both the current yield and the yield to maturity.
For stocks, par value has very little useful meaning to an investor in today’s markets. While par value of stock represents the minimum initial investment required to purchase shares from a company, today, most shares are issued with either no par value or a par value of 1¢ or less.
Par Value in Bonds
The value of par value in bonds is that par value serves as the benchmark price from which all other aspects of the bond can initially be calculated. These other aspects might be the coupon or the coupon rate of the bond, which effetely represent the interest rate and the nominal interest payment of the bond. These aspects are in addition to the fact that the par value represents the promised repayment amount of the bond at expiration.
To understand how par value factors into the calculation of the coupon rate and the coupon amount we can consider a simple example.
Let’s say that a company is considering offering a 10-year bond and wants to pay an annual interest rate of 5% on these bonds. To accomplish this, the company says it will issue these bonds with a par value of $1,000 each and an annual coupon rate of 5% where the coupons are paid annually. In this case, we know that the coupon rate, our initial interest rate on the bonds is 5%. This means that the company is borrowing $1,000 of every bond issued and paying an annual coupon of $50 per bond.
But what happens after the bonds are issued and maybe the global interest rate environment changes? At that point, we can use these initial values to calculate more meaningful values to use as investors later down the road. These calculations might be the current yield or the yield to maturity.
Par Value in Stocks
Par value of stock is the minimum but not the maximum a company can require for its shares. So, if a company has a stock with a par value of 1¢ they can still require $26 per share from investors. To understand this better consider our example.
Let’s say a company needs to raise capital and opts to raise this capital via a common stock offering. In our scenario, the company plans to issue 1 million shares of common stock with a par value of $100. If all goes right, the company should receive at least $100 million after issuing these shares.
However, if investors do not believe the company’s shares are worth $100, then the company may find it extremely difficult to raise the capital it desired as investors will be unwilling to pay $100. Additionally, if the company would become financially distressed and stockholders bought shares below their par value, those shareholders may be legally liable to cover the difference between what they paid and the par value to pay creditors.
In today’s environment, par value of stock is a remnant from the past. If a company decides to issues a par value on its shares, it is either due to state law or legacy. The important thing to note is that par value of shares has no bearing on the market value of shares.
Par Value vs Market Value
Regardless of whether or not par value is par value of bonds or par value of stock it is a fixed value set at the initial offering of the security. As you may expect, since it is a fixed value, the relevance of par value on what is the true value of the security will be imprecise to minimal depending on the circumstances.
The true value of the securities will often be represented in their market value. This is because relevant information such as the creditworthiness of the company, the interest rate environment, their earnings, their future outlook, and so on will be taken into consideration by potential investors. The view of the investors will then manifest themselves in the prevailing market value of the securities over time.
Frequently Asked Questions
A stock’s par value is the minimum investment amount a company can accept for the stock when initially issuing the shares. Today, the relevance of par value in association to shares of stock is minimal as par value of stock does not have any bearing on the market or true value of the shares.
Par value of stock is the minimum investment amount a company can accept for the stock when initially issuing the shares. Market value is the prevailing traded price of the shares at the current time.
A stock’s par value of $1 means that the company can accept nothing less than $1 per share when initially offering the shares to investors. This does not mean that the company cannot demand more to sell those initial shares. If an investor pays less than $1 for initial shares, they may be liable for the difference if the company ever faces bankruptcy.