When a bond is first issued, you pay face value. That's because you're buying it from the issuing company. However, if you buy a bond that is being resold by an investor who bought it as a new issue, you could pay a different price than face value.
It depends on the interest the bond pays. Sellers with bonds that pay high interest rates charge a premium. Sellers with low-interest bonds offer a discount.
Depending on the interest it pays, the price you pay for a bond may or may not be the face value.
Paying Par for New Bonds
You pay the face value of $100 – also known as "par" – when a bond is new. That's because a new issue most often offers an interest rate that is competitive with other new bonds. Because you earn the prevailing interest rate, sellers do not see any reason to offer you a discount, and there's no reason for you to pay a premium.
If you hold the bond to maturity, you will get $100 back for each bond you hold. Maturity is the life span of the bond. For example, you could buy a 10-year bond or a 30-year bond. That tells you how long they will pay you interest and then give you your original investment back.
Paying Below Par for Bonds
Some bonds get discounted because interest rates have gone up since the bond was issued. The old rate on the bond is not as high as what you could get on a new bond. To compensate you, sellers offer a discount.
For example, a seller may offer a bond at $98. That means if you buy the bond and hold it to maturity, you will get the face value of $100 paid to you. You make an extra two dollars per bond, plus all the interest you collect. This makes up for the lower interest you earn on the bond.
Paying a Premium for Bonds
You might pay above face value for a bond that pays higher interest than you can get with other bonds. This happens frequently when interest rates drop. New bonds pay a lower rate than older bonds. The older bonds are worth a premium because you get paid more interest.
You might pay $102 per bond to get that higher rate. If you hold the bond to maturity, you will only get back $100 per bond, so you have to decide if the higher interest is worth it.
Selling Your Bonds
You don't have to hold a bond to maturity to get your money out of it. You can sell it. That's when you have to decide whether you will sell it at face value, below par or above par. It all depends on prevailing interest rates, just like when you bought the bond.
If new bonds pay higher than yours, you may have to offer a discount to attract buyers. If new bonds pay less, you may be able to charge above face value and make some profit on your bond. If prevailing rates are about the same as what your bond pays, you may sell it for face value.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.