The face price, also known as the par value or nominal value, refers to the value that is printed on the face of a stock or bond certificate. It represents the amount that the company received when it originally issued the security. The face price is important for a few key reasons:
Calculating Returns
The face price is used to calculate the return on investment for a bond or preferred stock. For example, if a $1,000 face value bond is purchased for $900 and then redeemed at maturity for the full $1,000 face value, the investor earned an 11% return ($100 gain on a $900 investment). The face price provides a reference point for calculating yields and returns.
Determining Dividends
For preferred shares and some income securities, dividend payments are calculated based on a percentage of the face value. For example, a preferred share with a $100 face value and a 5% dividend would entitle investors to a $5 annual dividend per share ($100 x 5%). The face price allows investors to quickly determine the expected dividend payments.
Convertible Securities
For convertible bonds and convertible preferred shares, the face price determines the number of common shares investors receive if they convert their holdings. For example, a $1,000 face value convertible bond that is convertible at a price of $25 per common share would translate to 40 common shares ($1,000 / $25).
Balance Sheet Reporting
On the balance sheet, a company reports bonds payable at their face values, not their market values. This represents the actual amount the company owes bond investors when the bonds mature. Market values may fluctuate but the face values remain constant.
Influence on Market Value
While face price is distinct from market value, it can influence the market valuation. Securities are typically issued at or close to the face price. If interest rates rise after issuance, the market value of the security may decline below the face price. Conversely, market values above the face price indicate higher demand or lower interest rates.
Determining Discount or Premium
By comparing the face price to the market price, investors can quickly determine if a bond is trading at a premium or discount. For example, a bond with a $1,000 face price might trade at $1,100 indicating a $100 premium. A $900 market price would represent a $100 discount. The face provides a point of reference.
Impact on Taxes
When bonds or preferred shares are redeemed at maturity, investors are taxed based on the face amount, not the market value. If an investor purchased a bond at a discount, the gain over face value at maturity may be subject to capital gains taxes rather than ordinary income taxes.
Bankruptcy Claims
In the event a company declares bankruptcy, debt holders and preferred shareholders are typically entitled to receive the face amount of their investment. However, due to the bankrupt status of the company, investors frequently receive far less than the face amount.
Conversion Price
For convertible securities, the terms will specify a conversion price rather than a conversion ratio. For example, preferred shares may be convertible into common shares at a conversion price of $50. This means investors will receive common shares equal to the face value divided by $50. The conversion price provides an alternative way to calculate the conversion ratio.
Redemption Amount
Most bonds and some preferred shares can be redeemed by the issuer prior to maturity. The redemption amount is usually the face value plus any accrued interest or dividends. Investors receive the stated face amount upon early redemption.
Sinking Fund Provisions
Bonds may have sinking fund provisions that require the issuer to redeem a certain portion of the issue each year. The amount that must be redeemed is typically a percentage of the total face amount outstanding. Mandatory redemptions are designed to systematically pay down the bond issue.
Liquidation Preference
The liquidation preference of preferred stock specifies the amount per share that holders will receive in the event the company is liquidated and assets are distributed. This is normally equal to the face or par value and takes priority over common shareholders.
Face Amount in Insurance
In insurance contracts including life insurance or disability insurance, the face amount is the death benefit or amount payable in the event of a claim. This is the maximum that can be collected per the terms of the policy.
Conclusion
In summary, the face or par value represents the stated or nominal value of a security as printed on the certificate or document. It serves as a reference point for calculations, establishes payment terms, impacts accounting treatment, and sets parameters for bankruptcy/liquidation. Comparing the face value to the market price also enables investors to determine if a bond or preferred share is trading at a premium or discount relative to the amount received by the issuing company. Despite fluctuations in market values, the face value remains constant until final redemption or maturity.
Face Value Definition | Key Roles and Impacts |
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The stated or nominal value printed on a security certificate representing the amount received by the issuer. |
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Examples Comparing Face Values to Market Prices
Security | Face Value | Market Price | Description |
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6% Corporate Bond | $1,000 | $950 | Trading at a $50 discount to face value |
5% Preferred Stock | $100 | $110 | Trading at a $10 premium over face value |
Convertible Note | $10,000 | $9,500 | Note convertible into common shares at a conversion price equal to face value |
Using Face Value to Calculate Preferred Stock Dividends
Preferred stock pays set dividend amounts each year based on a percentage of the face value. For example, a 6% $100 par preferred share would pay a $6 annual dividend ($100 par x 6% dividend rate). The face value allows quick dividend calculations.
Face Value Role in Convertible Securities
For convertible bonds and convertible preferred stock, the face value helps determine the number of common shares investors will receive. If the conversion price equals the face value, divide face value by conversion price to get conversion ratio. For instance, a $1,000 convertible bond with a $1,000 conversion price converts into 1,000 common shares ($1,000 face value / $1,000 conversion price).
Using Face Value to Calculate Bond Discounts/Premiums
The market price of a bond can be compared to face value to determine if it is trading at a premium or discount. For example, a $1,000 face value bond trading for $1,100 indicates a $100 premium. A $900 market price represents a $100 discount from face value.
Accounting Treatment of Face Value
From an accounting perspective, companies record issued bonds on the balance sheet at face value rather than market value. This represents the legal liability owed to bond investors upon maturity. While the market value may change, face value is fixed.
For example, a company issues $10 million in bonds with a 6% coupon rate and 10 year maturity. Even if interest rates rise and the market value of the bonds drops to $9 million, the company will continue reporting the bonds on its balance sheet at the full $10 million face value. This represents the amount that must be repaid to investors at maturity.
Marking Bonds to Market
Although bonds are reported at face amounts on the balance sheet, companies do account for changes in market value each year. They “mark-to-market” the value of the bonds and report gains/losses separately without actually adjusting the face value liabilities. This provides a more accurate picture of the company’s full financial position.
Using Face Value for Tax Purposes
The face value of bonds and preferred shares impacts the taxes investors owe upon redemption. Gains over face value may be taxed at the more favorable capital gains rates rather than ordinary income tax rates. For example, an investor purchases a $1,000 face value bond for $900 then redeems it for the full $1,000 face value at maturity. The $100 gain may qualify for capital gains tax rates since it represents the gain over the stated redemption amount, even though the true gain was $100 on a $900 investment.
Original Issue Discount
Some bonds are issued with original issue discounts (OID). This means the bond is issued below its face value. For tax purposes, the OID is amortized over the bond’s term and treated as taxable interest income. Even though no interest is actually paid until maturity, the discount over face value accumulates as phantom income. Taxes are calculated based on face value, not the original issue price.
Preferred Stock Liquidation Preference
The liquidation preference of preferred shares specifies the amount per share that holders will receive if the company is liquidated and assets are distributed. This amount is typically the face or par value and takes priority over common shareholders. Setting a liquidation preference equal to face value helps assure preferred shareholders of receiving their original investment back first.
Sample Preferred Stock Liquidation Preference
Class A Preferred Stock has a face value of $100 per share and a $100 per share liquidation preference. In the event the company is liquidated, Class A shareholders will receive $100 per share before common shareholders receive any distribution. This liquidation preference at full face value provides significant protection for preferred investors.
Using Face Amount in Insurance Policies
In various insurance contracts like life insurance or disability insurance, the face amount represents the death benefit or dollar amount payable to beneficiaries in the event of a claim. This serves as the upper limit of how much can be collected according to the policy’s terms. The face amount may also be known as the policy limit or death benefit limit.
Sample Insurance Policy Face Amounts
Insurance Product | Face Amount | Description |
---|---|---|
Term Life Insurance | $500,000 | Death benefit payable to beneficiaries is $500,000 |
Disability Insurance | $3,000/month | Provides $3,000 maximum monthly benefit if disabled |
The face amount or death benefit limit represents the maximum payout based on the contractual terms. Lower amounts may be paid out depending on the circumstances of the claim. But the face amount sets the upper bound on the insurer’s liability.
Sinking Fund Provisions in Bonds
Some bond contracts contain sinking fund provisions that require the issuer to redeem a portion of the bonds each year before maturity. The amount required to be redeemed is typically calculated as a percentage of the total face value outstanding.
For example, a $10 million bond issue with a 5% annual sinking fund provision would require the issuer to redeem $500,000 worth of bonds per year over the bond’s 20 year term ($10 million x 5%). The sinking fund redemptions systematically pay down the issue over time.
Advantages of Sinking Funds
- Allows orderly repayment of the bond issue over time
- May improve the credit quality of remaining bonds
- Provides flexibility to redeem lowest cost bonds
- Gives investors access to principal before maturity
By specifying annual redemptions as a percentage of face value, sinking funds provide a structured mechanism for issuers to reduce debt obligations.
Key Takeaways on Face Value
In review, the key points to understand about face or par value include:
- Represents the stated or nominal value printed on a security certificate
- Used to calculate returns, dividends, and conversion ratios
- Bonds are reported on balance sheet at face value, not market value
- Comparing to market price shows premiums/discounts
- Influences tax treatment of investment gains/losses
- Sets liquidation preference and redemption amount
- Equals death benefit and policy limits in insurance
Despite changes in market values, face value provides a constant reference point for investors and issuers over the security’s life until a final redemption event. Understanding the meaning and uses of face value is essential for investors, financial analysts, and accounting professionals.