Face value of bond
When a bond is first issued, it has a face value, which can be Rs 100, Rs 1000 and so on. This face value determines the price at which a bond trade in the market. For example Gsecs trade at Rs100 face value and below or above Rs 100 when interest rates change.
There is always an interest rate attached to a face value of a bond. The interest rate is also the coupon rate of the bond, which determines the cash flow you get from investing in the bond. So when government of India issues 6.10% bond with face value of Rs 100, the bond pays Rs 6.10 every year as interest, in this case on a semi-annual basis.
There are also bonds that do not pay interest but are issued at price below face value and on maturity the investor gets the face value of the bond. These are called deep discount or zero coupon bonds. For example a bond with face value of Rs 100 is issued at Rs 90 and on maturity the investor gets Rs 100, the Rs 10 gain is not capital gain but is interest income as the bond does not pay coupon interest.
Below or above face value
A bond with a face value of Rs 100 and is trading at Rs 99 is said tp be trading at below face value and when it is trading at Rs 101, it is said to be trading at above face value. The reason bonds trade below or above face value is due to investor demand, which is determined by their outlook on various factors such as inflation, macro economic stability and fundamentals of the issuer of the bond. For example, the 6.10% gsec is trading in at Rs 99 as investors demand is low as they believe inflation will rise in the economy and 6.10% interest rate will not compensate for rise in inflation.
A discount to face value bond is actually a bearish indicator
At first glance, discount bonds may seem like an easy choice. Just buy a discount bond at Rs 95 and benefit as its price rises to Rs 100. Buying a bond at Rs 105 that’s going to mature at Rs 100 seems to make no sense. However like in equities, bonds that trade at premium indicate better fundamentals than bonds that trade at discount. In other words, risk in investing is bonds that trade at discount is higher than investing in bonds that trade at premium, unless there are other fundamental considerations.
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