Par Value

Published Apr 29, 2024

Definition of Par Value

Par value, also known as nominal value or face value, is a term used mostly in finance to denote the stated value or face value of a financial instrument. For stocks, it is the minimum price at which shares can be issued, as specified in the corporate charter. In the context of bonds, the par value is the amount that will be returned to the bondholder at maturity. It is important to note that the par value of a stock or bond does not necessarily reflect its market value or selling price, which can be higher or lower depending on various factors such as market conditions, investor beliefs, and the financial health of the issuing company.

Example

Consider a company, XYZ Corp., that decides to issue 1,000 shares of stock with a par value of $10 each. This means the total equity capital that the company will record for this issuance is $10,000. However, if the market conditions are favorable, XYZ Corp. might issue these shares at a price higher than the par value, say $15. The additional amount over par, in this case, $5 per share, is referred to as the share premium or additional paid-in capital.

On the other hand, if XYZ Corp. issues bonds, the par value represents the amount it promises to pay back to the investors at maturity. For example, if it issues bonds worth $1,000,000 at par value, upon maturity, the bondholders expect to receive the face value of their bonds totaling $1,000,000, irrespective of the price they initially paid to purchase them.

Why Par Value Matters

The concept of par value is critical for several reasons:

– Legal Requirements: In some jurisdictions, the par value of shares represents the minimum legal capital that a company must maintain and cannot distribute to shareholders through dividends. This legal stipulation helps protect creditors by maintaining a capital buffer.
– Accounting Practices: Par value plays a role in accounting for equity and debt instruments. For stocks, it helps determine the allocation between common stock (or preferred stock) and additional paid-in capital on a company’s balance sheet.
– Bond Pricing: For bonds, the par value is crucial for determining coupon payments, as these are often expressed as a percentage of the par value. Moreover, at maturity, bondholders receive the par value, which helps investors calculate yield and returns.

Frequently Asked Questions (FAQ)

Does Par Value Affect the Market Value of a Stock or Bond?

Par value does not directly affect the market value of a stock or bond. Market values fluctuate based on demand and supply dynamics, the financial performance of the issuing entity, and the overall economic environment. For stocks, par value is largely symbolic today, with many companies setting it at a minimal amount. Bonds trade at discounts or premiums to par value based on interest rate movements and the creditworthiness of the issuer.

Why Do Companies Issue Stock with Low or No Par Value?

Companies issue stock with low or no par value to avoid liability. If a stock with a higher par value falls below its issue price, the company might be legally obligated to cover the difference. Low or no par value reduces this risk, giving companies more flexibility and reducing potential legal liabilities.

Can a Bond Sell for More Than Its Par Value?

Yes, bonds can and do sell for more than their par value. This typically happens when the coupon rate (the interest rate paid on the bond) is higher than the current market interest rates for similar bonds. In such scenarios, the bond is said to be selling at a premium. Conversely, if the market rates exceed the coupon rate, the bond might sell for less than its par value, or at a discount.

What Happens if a Stock’s Market Price is Below its Par Value?

While the market price of a stock can drop below its nominal or par value, this event has no direct legal or economic implications regarding the par value itself. The par value remains a fixed figure on the books. However, a significantly lower market price might reflect the company’s poor financial health or market sentiment, which could have broader implications for the company’s operations and financial stability.

The differentiation between par value and market value highlights the complex nature of financial instrument valuation, underscoring the importance of comprehensive financial analysis in investment decision-making.