Nominal Value – Meaning, Importance, Drawbacks and More

Nominal Value (NV) is a common term used in finance and economics. In the field of finance, we use it primarily for bonds and stocks. It refers to the face value or par value of the security or its redemption price. The NV of security is generally given on the front/ face of that security.

In economics, the NV is the unadjusted rate or the rate without adjusting for inflation and other relevant factors.

Nominal Value in Finance

For any security, a bond or stock, the nominal value is the value that does not change until the maturity. In contrast, the market value of a security change as per the change in the external factors, including inflation. Or, we can say NV is the amount that the bondholders usually get at the time of maturity. Generally, the corporate bonds carry an NV of $1,000, while municipal bonds’ NV is $5,000.

For example, Company A issues bonds worth $5 million with a face value of $1,000 to finance its new project. The maturity of the bond is ten years, and it carries an annual interest rate of 5%. In this case, the bondholder will get the NV or face value of $1,000 at the end of ten years. The bondholder will get $50 per year in interest payments.

Talking of ordinary stocks, NV is an arbitrary value that a company needs for use in the balance sheet. It has no impact on the market value of the stock. For example, a company gets permission to raise $2 million in equity, and the par value is $1. In this case, it can issue up to 2 million shares.

The difference between the selling price and the face value of a stock is the share premium. On the balance sheet, this share premium will come as additional paid-in capital. For example, if the company can sell $2 million face value equity at $4 million, then $2 million will be paid-up share capital, and the balance will come as additional paid-in capital.

Similar to bonds, the NV is essential for the preference shares as well. A company uses NV to calculate the dividend amount for the preference shares. For example, a company issues a 10% preference share with a nominal value of $100. In this case, the dividend amount will be $10. The market value of the preference share, in turn, will depend on the dividend. If the market is okay with a 10% dividend, then the stock will trade at par value. If the market expects more dividends, the share will trade at a lower price than the nominal value and vice versa.

Nominal Value in Economics

In economics, the NV is just the current prevailing monetary value.  This prevailing value does not account for any adjustments for inflation. When comparing numbers over some time, the NV is not much of use as it does not factor inflation.

Real rate = Nominal rate Less Inflation rate

Nominal Value

Importance

Following points reflect the importance of nominal value:

  • For bonds and preferred stock, the NV is essential to calculate the interest payments, market value, yield, and more. In the above example, we used the face value to calculate the annual interest on the bonds. Interest on bonds is a percentage of nominal value. Also, the redemptions premium that bondholders may get is a percentage over the bond’s face value.
  • The nominal value affects the price of the bonds as well. Bond prices show as a percentage of the NV. The market price of a bond may be above or below or equal to the face value depending on the interest rates. If the market interest rate is above the bond’s interest rate, then the price of the bond will drop, and vice versa.
  • Though companies issue bonds at face value, later these bonds trade at a premium or discount to the nominal value. The premium or discount depends on the market conditions and the reputation of the issuer.
  • For preference shares also nominal value is significant. It helps in calculating the dividend amount and market value.
  • GDP value is also expressed in nominal terms. GDP (Gross Domestic Product) is the total amount of goods and services that a country produces. It is a measure of a country’s financial well being, with high GDP suggesting a strong economy.

Nominal Value vs. Market Value

As said above, the NV is the face value or the par value that remains constant. On the other hand, the market value is not consistent. The market value continues to fluctuate. And the fluctuation depends on the demand and supply of the security, as well as external factors.

For example, Company A issues its shares at face value of $10. It will not change. After it lists its shares on a stock exchange, the value of shares shoots up to $40. This $40 is the market value.

Another difference between the two is that NV is assigned arbitrarily, while demand and supply forces determine the market value.

Nominal Value vs Real Value

It is essential to know the difference between nominal and real value when it comes to economics. In economics, the NV is the value or percentage without adjusting for inflation. The real value, on the other hand, is the actual value that an investor would realize after adjusting for inflation.

Calculating real values gets very important in cases where inflation may skew the results significantly. For example, a bond offers a coupon rate of 3%, but inflation is 3.5%. The real rate, in this case, will be -0.5%, meaning the investor is actually at a loss with 3% interest.

GDP (Gross Domestic Product) figures are also in nominal terms. However, they do not always give the right picture. If a country has experienced a GDP growth, then the growth could be due to an increase in the price levels. If such is the case, then it is not the sign of a healthy economy. To get the accurate picture, we need to find the real GDP figure.

Drawbacks

Even though the nominal values are simple and easy to understand, they suffer from a few drawbacks as well. These are:

  • One should not just depend on the NV to make a decision. Often nominal values do not give an accurate picture.
  • We must always base investment decisions on the real rate of return. It is because; taxes, inflation, and other costs play a crucial role in deciding whether or not to go for an investment. For example, if you are considering investing in a foreign country, then along with the nominal interest, you must consider the inflation rate, currency exchange fluctuations, and other factors to determine the viability of an investment.
  • In terms of economics, the nominal value is useless when comparing over time. It is because it does not adjust for inflation.

 

 

 

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What is Nominal Value? – Definition | Meaning | Example. My Accounting Course. [Source]
Last updated on : August 1st, 2020
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