Issue Price of a Bond
The issue price of a bond is the price at which a bond is originally sold to investors by the issuer. The issue price is determined by adding the present value of the bond’s principal amount (also known as its face value or par value) to the present value of its future interest payments. This calculation involves discounting the future cash flows of the bond to the present using a discount rate, which is often the market interest rate for bonds with similar characteristics.
There are three possible scenarios for the issue price of a bond:
- At Par: If the bond’s coupon rate (the interest rate stated on the bond) is equal to the market interest rate, the bond is issued at its face value, or “at par.
- At a Premium: If the bond’s coupon rate is higher than the market interest rate, the bond is issued at a price higher than its face value, or “at a premium.” Investors are willing to pay more for this bond because it offers a higher return than other similar bonds in the market.
- At a Discount : If the bond’s coupon rate is lower than the market interest rate, the bond is issued at a price lower than its face value, or “at a discount.” Investors will only buy this bond if they can get it at a lower price because it offers a lower return than other similar bonds in the market.
Once the bond is issued and starts trading in the secondary market, its price can fluctuate based on changes in interest rates, the creditworthiness of the issuer, and other market factors. But the issue price is set only once, at the time the bond is issued.
Example of the Issue Price of a Bond
Let’s say that ABC Corporation decides to issue a bond with a face value of $1,000, an annual coupon rate of 5%, and a maturity period of 10 years. This means the bond will pay $50 in interest each year (5% of $1,000) for the next 10 years, and then repay the $1,000 face value at the end of the 10th year.
Let’s consider three scenarios:
- At Par: If the market interest rate for similar bonds is also 5%, then the issue price of the bond will be its face value, $1,000. The coupon rate equals the market rate, so the bond is issued at par.
- At a Premium: If the market interest rate for similar bonds is 4%, then the issue price of the bond will be higher than its face value. Investors are willing to pay more than $1,000 for this bond because its 5% coupon rate gives them a higher return than the 4% market rate. The exact premium price would be determined by discounting the bond’s cash flows at the 4% market rate.
- At a Discount: If the market interest rate for similar bonds is 6%, then the issue price of the bond will be lower than its face value. Investors are only willing to buy this bond if they can get it for less than $1,000, because its 5% coupon rate gives them a lower return than the 6% market rate. The exact discount price would be determined by discounting the bond’s cash flows at the 6% market rate.
This is a simplified example and the actual calculation of a bond’s issue price would require using present value formulas, but it illustrates the basic concept of how a bond’s issue price is determined and how it can be issued at par, at a premium, or at a discount.
