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The Advantage of Bonds Being Priced off Par Value

Many investors may hear the term "par value," shrug, and ask "What's the big deal?". While the concept is straightforward, the fact that individual corporate bonds trade as a percentage of their par value creates a distinct advantage for investing in individual bonds vs. bond funds. In this bond investing FAQ article, we explain how investors can use the way individual bonds are priced to assess the value of new corporate bond investments. We also discuss why investors cannot assess the value of bond funds and ETFs, as these investments trade off an arbitrary net asset value per share and lack the underlying financial metrics of individual corporate bond issuers.

What is the par value of a corporate bond?

The par value of a corporate bond is $1,000 and represents the amount a bond issuer must pay bondholders for each bond owned on a bond's maturity date. It's similar to par on a golf course only you get money in your pocket rather than personal satisfaction. In golf, a good player should make par or better on a hole. In bonds, a 'good bond' (one where the issuer doesn't default prior to a bond's maturity date) pays the holder the par value of the bond at maturity.

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BondSavvy founder Steve Shaw and his Dad, Robert Shaw, playing in the annual Father's Day tournament at the course Steve grew up playing, Allentown Municipal Golf Course, in Allentown, PA. Their red team color represented all the birdies they hoped to make in the two-man-scramble event.

Bond investors use the terms par value and face value interchangeably. The par value of a bond is the same for the entire life of the bond, which is very different than the market value of the bond, which can fluctuate regularly.

How are corporate bonds quoted relative to a bond's par value?

Individual corporate bonds are quoted as a percentage of their par value. For example, a corporate bond quoted on an online bond trading brokerage at 98.00 would be worth $980, or 98% of the $1000 par value of the bond. Since this bond is quoted below the $1,000 of a par value bond, it is called a discount bond. A corporate bond quoted at 105.00 is worth 105% of the bond's par value, or $1,050. Bonds priced above par value are known as premium bonds.


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As shown in Figure 1, par value is the anchor of the bond pricing scale. Throughout the life of a corporate bond, the market price can fluctuate to where the bond becomes a discount bond or a premium bond. The key rule around bond pricing, however, is that, on the bond's maturity date, the bondholder receives the bond's $1,000 par value. This rule has a major impact on how corporate bonds trade, as, generally speaking, bonds that are very close to their maturity dates will typically have limited pricing volatility compared to bonds that have a long time to maturity. In addition, there is effectively a ceiling placed on how high a corporate bond price can increase since the bond has to return to par value on the bond maturity date.

Figure 1: Bond Pricing Scale

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In extremely rare circumstances, a corporate bond could soar above 150.00. That said, this is a key difference of corporate bonds vs. stocks, as stocks don't have a maturity date and their prices can increase without an upper limit. The ceiling on corporate bond prices is a big reason why we advocate selling bonds before maturity to secure upside and maximize our total investment return. For example, if we recommend purchasing a corporate bond at 90.00 and the price increases to 130.00, unless we believe a catalyst remains for the bond price to continue increasing, we will likely recommend selling the bond.

To illustrate the ceiling on corporate bond prices, Figure 2 shows the distribution of high yield corporate bond prices from two Fidelity bond searches: one on May 16, 2021 and another on December 2, 2021. In both cases, there was only one bond priced above 150: the Ford Motor 9.980% 2/15/47 bond (CUSIP 345370BW9), which was issued way back in 1998 at a high coupon. As Figure 2 illustrates, as a bond moves farther up the bond pricing scale, the opportunity for the price to keep increasing gets smaller.

Figure 2: Distribution of High Yield Corporate Bond Prices from Fidelity.com Bond Searches

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Source: Fidelity.com corporate bond searches.

There is one other important conclusion we can draw from this bond price chart: it was slightly easier to find bargains on May 16, 2021 vs. December 2, 2021. BondSavvy's bond investment strategy is focused on maximizing total returns. Similar to stocks, we want to buy low and sell high. The bars bracketed in orange show the bonds priced below 95.00. On May 16, 2021, 9.8% of the 1,120 bonds were priced below 95.00 compared to 7.0% on December 2, 2021.

As many high yield corporate bond issuers have reported strong financial performance over the last several quarters, the high yield corporate bond market has generally performed well, with many bond prices increasing significantly beginning mid-March 2020. Bond selection becomes even more important in periods of higher bond prices, as there are, unfortunately, more mistakes that can potentially be made.

Advantages of Bonds Priced Relative to Par Value

Since corporate bond prices trade relative to a bond's par value, bond prices enable investors to assess their relative value compared to other corporate bonds. Investors cannot assess the relative value of bond funds and ETFs since they trade based on a value per share that is not anchored to a metric similar to a bond's par value. With individual corporate bonds, investors can compare trading metrics such as YTM, the bond's price relative to par value, and credit spread to credit metrics, such as leverage ratios, to determine whether a bond is a good value. Such credit and pricing metrics do not exist in the world of bond funds and bond ETFs.


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Figure 3 provides an example of how select bond funds, bond ETFs, and individual corporate bonds were priced as of December 2, 2021. The pricing of the two individual bonds -- Walmart Inc. 2.500% 9/22/41 (CUSIP 931142EU3) and Netflix 5.875% 11/15/28 (CUSIP 64110LAT3) -- was straightforward. Both bonds are priced as a percentage of their face value, with the Walmart bond trading at 101.59% of its par value and the Netflix bond trading at 120.15%. We could also see that the credit spreads for both bonds were fairly narrow: 0.57% or 57 basis points for the Walmart '41 bond vs. 1.36% or 136 basis points for the Netflix bond. With the bond price information in hand, we can apply our bond investment analysis to determine whether either the Walmart bond or the Netflix bond represents a compelling value.

Figure 3: Illustration of Pricing of Individual Bonds vs. Bond Funds


Security
Ticker / CUSIP Price 12/2/21* Credit Spread*
How Priced
When Priced
iShares iBoxx $ Investment Grade Corp Bond ETF Ticker LQD 132.86 NA $ per share, which can be
different than ETF's NAV/share
Throughout the day
iShares iBoxx $ High Yield Corp Bond ETF Ticker HYG 85.65 NA $ per share, which can be
different than ETF's NAV/share
Throughout the day
Vanguard Total Bond Market Index Fund Ticker VBTLX 11.28 NA NAV / share End of day
Walmart Inc. 2.500% 9/22/41 CUSIP 931142EU3
101.59 0.57% % of Face Value Throughout the day
Netflix 5.875% 11/15/28 CUSIP 64110LAT3 120.15 1.36% % of Face Value Throughout the day

*Prices for LQD, HYG, and VBTLX are from Yahoo! Finance. Prices for the Walmart and Netflix bonds are top-of-book offer prices from Fidelity.com.

Since the three bond funds are not priced relative to par value, it is impossible for investors to determine whether the 11.28 price for VBTLX is a good value. We can't compare the price to par value, the fund doesn't have a credit spread, and we cannot calculate basic credit metrics such as leverage ratios. Investors in individual corporate bonds have these investment analysis arrows in their quivers, which provide a significant advantage of individual bonds vs. bond funds.

Accuracy of pricing

There is another factor in how individual bonds, bond funds, and bond ETFs are priced, which provides a greater level of transparency and accuracy for individual bonds. At any time during the trading day, investors can open their online brokerage account and see the up-to-the-second price of an individual corporate bond they want to buy.

While bond price volatility is typically less than that of stocks, corporate bond prices move up and down based on factors such as bond issuer financial performance, Treasury yields, bond fund inflows and outflows, and other bond market dynamics. The bond market is not perfectly efficient; however, material events and market factors can and will cause bond prices to move over the course of a trading day.

Compare this to a traditional bond fund such as VBTLX, which price only gets updated at the end of the day. Worse are bond ETFs, such as iShares LQD and iShares HYG, which have prices that move up and down during the day, but the underlying value of the holdings in the fund only gets priced at the end of the day. Other than the typically weak returns of bond funds, this lack of pricing transparency is another reason why we favor owning individual corporate bonds over bond funds and ETFs.

How a corporate bond's par value impacts coupon payments

Over the course of a corporate bond's life, its YTM, current yield, price, and credit spread move throughout each trading day. The fixed parts of the bond investing equation are a bond's coupon, maturity date, and par value. Since the bond's par value and coupon do not change between bond issuance and maturity date, coupon payments for each bond remain the same.

Figure 4 shows the annual bond coupon payment calculation for the Walmart '41 bond (CUSIP 931142EU3) we showed in Figure 3. To determine how much bondholders receive each year, multiply the $1,000 par value of the bond by the 2.500% coupon. This results in an annual coupon payment of $25.00 for each bond an investor owns. Interest on corporate bonds is paid semi-annually: once on the month and date of the maturity date (September 22 for this Walmart bond) and once on the date that is six months after this date (March 22 for this Walmart bond). In the case of the Walmart '41 bond, an investor who owned 10 bonds would receive $125.00 every March 22 and $125.00 every September 22. Should the investor sell a bond in between coupon payment dates, in addition to receiving the market value of the bond sold, she would receive accrued interest from the most recent coupon payment date until the date on which the trade settled.

Figure 4: Annual Bond Coupon Payment Calculation for Walmart 2.500% '41 Bond

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While a corporate bond's annual coupon payment does not change, current yields and YTMs are ever changing. We will be publishing blog posts on these important bond investing metrics shortly.

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