Smart Bond Investing—Bond Basics
Bonds are generally issued in multiples of $1,000, also known as a bond's face or par value. But a bond's price is subject to market forces and often fluctuates above or below par. If you sell a bond before it matures, you may not receive the full principal amount of the bond and will not receive any remaining interest payments. This is because a bond's price is not based on the par value of the bond. Instead, the bond's price is established in the secondary market and fluctuates. As a result, the price may be more or less than the amount of principal and the remaining interest the issuer would be required to pay you if you held the bond to maturity.
The price of a bond can be above or below its par value for many reasons, including interest rate adjustments, whether a bond credit rating has changed, supply and demand, a change in the creditworthiness of a bond's issuer, whether the bond has been called or is likely to be (or not to be) called, a change in the prevailing market interest rates, and a host of other factors. If a bond trades above par, it is said to trade at a premium. If a bond trades below par, it is said to trade at a discount. For example, if the bond you desire to purchase has a fixed interest rate of 8 percent, and similar-quality new bonds available for sale have a fixed interest rate of 5 percent, you will likely pay more than the par amount of the bond that you intend to purchase, because you will receive more interest income than the current interest rate (5 percent) being attached to similar bonds.