What is Par Value?
Par value is also known as the face value or nominal value of the securities such as shares, debentures, and bonds. It refers to the minimum amount at which per share or bond is issued to the investors/lender.
In the case of fixed income securities such as bonds, debenture the face value or nominal value is the main component of raising money from the borrowers/investors. Par value represents the contractual agreement between the issuer and the lender. This agreement makes the issuing entity liable to repay the face value indicated on the bond certificate to the lender/investor on maturity.
For example, if a company issues 100 bonds with a face value of Rs. 100 per bond to the lender repayable on a future date. So, when the bond matures, the company has to repay 10,000 (100 x100) to the lender.
But in the case of shares, par value is not of much importance. As it represents only the face value and thus the part/share of the holder in the nominal/ paid-up capital of the company. However, a company can issue the shares at a premium at the time of offering. And the prices keep on changing in the stock market. In other words, the par value remains valid for financial statement presentation and dividend distribution purposes.
Face value is indicated on the bond or share certificate issued by the company / Government to the investor. It is static and does not fluctuate like the market value of a share or bonds. A company also generally specifies the par value of the securities issued in its articles of association.
Par Value of a Share
While referring to share, we often use terms such as at par, above par, or below par. Usually, the par value of the shares is the minimum amount per share at which a company can offer its shares to the public. By issuing shares, the company accumulates equity capital. Hence the face value is the minimum amount required to subscribe to the shares of a company for all at par offerings.
Before the electronic version of share issuance, the companies used to issue share certificates to the investors indicating the face value of the shares. Previously it was permissible to issue shares below par. However, then the shareholders remain liable to the creditors for the differential amount in case of a shortfall in capital. So, in line with regulatory changes, now the companies cannot issue shares below the face value. Nevertheless, a company can always issue its shares at a premium above the face value. The money received as a premium is accounted for in the separate account known as the share premium account. The share capital account indicates the face value and paid-up value of shares.
Understanding with Example
A company Bardhhaman Ltd. issues 1 lakh shares for public subscription, and each share has a face value of rupees 10. Then Rs. 10 is the minimum price to issue or purchase the shares of Bardhaman ltd.
The total worth of shares = face value x no of shares= Rs. 10 x 100,000=10,000,000
The face value of the shares is usually in small denominations such as Rs.10, Rs 5, and Rs.1. A company reports the total par value of shares in its balance sheet under the head shareholder’s equity as a capital contribution or paid-up capital.
The concept of the nominal value or face value has undergone a sea change in the present context of shares/stock. It has now become optional, and a company may choose to issue no par value or low par value stock. In case the company sets no par value, the share certificate must mention -‘ No par value’ on the face of the certificate.
Par Value of Bonds
A bond is an agreement of loan between the two parties, where the person issuing the bonds is the borrower of the money and agrees to repay the borrowed amount at a predetermined date to the investor or the lender. The set date is the date of maturity of the bonds. The Par value of the bond refers to the amount that the bond issuer (borrowing party) has to repay to its bondholders (lender/investor) upon maturity.
Issuers may not always issue bonds at par. It could be at a discount (below par) or a premium (above par). The par value remains the same and is not affected by the issue price. Moreover, the redemption of bonds on maturity could be at par value or a premium, in line with the terms of the issue.
Understanding with Example
Suppose a bond has a face value of Rs. 400 is trading at 480; then, it is trading at a premium. On the contrary, if it is trading at Rs. 380, then it is selling at a discount.
A bond issued at a premium or discount depends upon several factors, such as the interest rate offered vs. what is prevailing in the market, the financial strength of the company, its credit rating, the business prospects of the company, etc. The coupon rate or the interest rate is the compensation that the bondholders get for lending their money to the bond issuer.
Suppose a risk-free return is prevailing at 6% in the market. The company is also offering the same rate, which means the company is quite stable in all aspects – mostly government companies or guaranteed by the government. Usually, to attract a lender/investor, a company needs to offer a higher rate of interest than the risk-free rate of return. Moreover, this differential would go on to widen as per the financial standing of the company. So, the lower the strength and rating of the entity offering the bonds, the higher would be the interest rate.
Suppose a company’s bond with a coupon rate of 6% is trading where the prevailing interest rate is also 6%. It is trading at par. And if the current interest rate is 7.5 %, the bond with 6 % would trade at a discount. Conversely, if the prevailing interest rate is 5%, bonds with a 6 % offering would trade at a premium in the market.
Difference between Par Value and Market Value
The main difference between the par value and market value are below:
|It is the stated value of the market securities. It is printed on the face of the share and bond certificate.||It is the stated value of the market securities. It is printed on the face of the share and bond certificate.|
|Face value is static and is not affected by the fluctuation in the market rate.||It fluctuates from time to time as per the market conditions and activities.|
It sets the benchmark for pricing for the company issuing bonds. Factors such as the interest rate prevailing in the market and the credit status of the bond affect the market price of the bond. The market price of the bonds may be above or below the par value. If it is trading above par, it is trading at a premium as it offers a higher interest rate than the current market rate. The investor pays more as he expects higher returns. However, bonds trading below par have a low-interest rate than the market rate.
Par value is also necessary for startups or businesses keen to raise money from the public by issuing shares. At an early stage, the entity may not be able to offer shares at a premium; hence, still, it is the usual practice to put a par value on shares. Setting a par value also binds the company not to offer shares below par value.