Above Par (Bond Price) Definition
Above par is the term used to describe the price of a bond that is trading at a premium above its face value. It happens when the income distributions of a bond are above those of others available in the market. It is caused by declined interest rates which lead newly issued bonds to experience lower coupon rates.
A Little More on Above Par Priced Bonds
The correlation between bond yields and prices is inverse. This means that in an economy, when declining interest rates leads to a drop in yields, the prices of bonds increase. Also, when interest rates in the economy increase, the prices of bonds conversely decrease as long as there is no negative bulge.
The reason behind this inverse relationship is that the yield of a bond already existing is supposed to match that of a newly issued one, with either higher or lower current interest rates.
For example, assume that a bond is issued with a face value of $1000 and a coupon rate of 5%. After six months the economy slows down, and this leads to a decline in the interest rates. Due to the opposite relationship between its yield and price, the bond will trade above its face value.
Investors who purchase bonds that trade above face value enjoy higher interest payments. This is because the coupon rates were set in a market experiencing higher interest rates. In the situation where the bond is taxable, the investor may offset the taxable interest income by amortizing the bond premium. Where the bond produces tax-exempt interest, the investor is required to write off the premium according to the IRS rules gradually.
The bond’s duration determines the movement above par for a non-redeemable bond. The higher the period, the greater the responsiveness to interest rate changes. For example, a bond which has a span of 10 years will experience a 10% increase in its prices, should the yield drop by 1% or 100 basis points.
For redeemable bonds, however, their likeliness of being redeemed when the interest rates decline limits their increase in price above par. This is because the issuer of the bonds will recall those bonds, and issue new ones that will have lower coupon rates.
Reference for Above Par Bond Pricing
Academic research on Above Par Price of Bonds
- Share capital and creditor protection: efficient rules for a modern company law, Armour, J. (2000), The Modern Law Review, 63(3), 355-378. The article inspects the rules of company law regulating how companies raise and maintain share capital. The particulars of company law are evaluated, and the rules governing share capital are being given special attention and this grants the inquiry relevance. These rules are generally seen as a way of protecting corporate creditors. Therefore, the analysis tries to find out whether rules can be viewed as responses arising from failures of corporate credit markets.
- Analyzing convertible bonds, Brennan, M. J., & Schwartz, E. S. (1980), Journal of Financial and Quantitative analysis, 15(4), 907-929. A convertible bond is a hybrid bond which offers the positive potential that is related to the underlying common stock while still retaining the majority of straight debt characteristics. In reciprocation to the upside potential, a convertible bond has a lower coupon rate than a straight bond and also it is subordinated to other corporate debt.
- Convertible bonds: Valuation and optimal strategies for call and conversion, Brennan, M. J., & Schwartz, E. S. (1977), The Journal of Finance, 32(5), 1699-1715. This study focuses on the valuation and optimal strategies that are employed for call and conversion of convertible bonds
- Purchase of Shares of Corportation by a Director from a Shareholder, Wilgus, H. L. (1909). Mich. L. Rev., 8, 267. This article explains the relationship that exists between a director and the shareholder. The director is in his capacity and not as an agent of the corporation or the body of shareholders.
- “Watered Stock”: Commissions:” Blue Sky Laws”: Stock without Par Value, Cook, W. W. (1921), Michigan Law Review, 19(6), 583-598. This article explains the relationship between watered stock and stock without par value. Watered stock refers to issuing stock at a higher cost than the underlying assets possessed by a company. Whereas, stock without par value is defined as the stock that is issued by a company, but its par value is not included in the stock certificate or the articles of incorporation of the company.
- Determinants of risk premiums on corporate bonds, Fisher, L. (1959), Journal of Political Economy, 67(3), 217-237. This is an article that explains factors that determine the risk premium that accompanies corporate bonds.
- Progress of the Law on No Par Value Stock, Wickersham, C. W. (1923), Harv. L. Rev., 37, 464. This article explains the matters of the law that govern no par value stock. Stock without par value sometimes is viewed as a way of mitigating fraud on investors who attend the sale on a public par value of a stock.
- Uses of Stock Having No Par Value, Hollen, R. H., & Tuthill, R. S. (1921), American Bar Association Journal, 7(11), 579-582.This study explains the various uses that accompany the possession of stock with no par value.
- DEPARTMENT OF PROFESSIONAL TECHNIQUE: Capitalization of Corporations Issuing Shares Without Par Value, Mitchell, W. D. (1925), American Bar Association Journal, 11(6), 377-380. This article major’s on the corporations that issue shares without par value and their capitalization.
- Shareholders’ Pre-emptive Rights, Frey, A. H. (1928), Yale LJ, 38, 563. This article explains the privileges that sometimes are extending to various shareholders giving them the right of acquiring additional shares in the company before they open to the general public for purchase in a seasoned offering.