Show pageOld revisionsBacklinksBack to top This page is read only. You can view the source, but not change it. Ask your administrator if you think this is wrong. ======Principal (Bond)====== Principal (also known as [[face value]], [[par value]], or nominal value) is the amount of money a [[bond]] issuer borrows and promises to repay to the investor when the bond reaches its end date, or [[maturity]]. Think of it as the original "I.O.U." amount written on the bond certificate. When you buy a bond, you are essentially lending this principal amount to a company or government. In return for your loan, the issuer pays you regular interest, called a [[coupon]], which is almost always calculated as a percentage of this fixed principal amount. For example, if you hold a bond with a $1,000 principal and a 5% coupon rate, you'll receive $50 in interest each year. At the end of the bond's term, assuming the issuer doesn't [[default]], you get your original $1,000 principal back. It’s the bedrock of the bond agreement, the sum the entire deal is built upon. ===== The Principal in Action ===== ==== Foundation of a Bond's Value ==== The principal is the anchor of a bond investment. It serves two critical functions: * **Repayment Guarantee:** It's the specific amount you are contractually entitled to receive at maturity. This repayment of principal is the core promise from the issuer to the bondholder. * **Interest Calculation Base:** It's the reference figure used to calculate your income. A higher principal, at the same coupon rate, means a larger interest payment. ==== Principal vs. Market Price: A Crucial Distinction ==== Here’s where many new investors get tripped up. The principal is a **fixed** amount that never changes throughout the life of the bond. However, the price you pay for that bond on the open market—its [[market price]]—can and does fluctuate. This difference is key. * **Trading at Par:** If you buy a $1,000 bond for exactly $1,000, you are buying it //at par//. * **Trading at a Discount:** If prevailing [[interest rate]]s rise after the bond is issued, newer bonds will offer better returns. To compete, the market price of our older, lower-interest bond might fall to, say, $950. It is now trading //at a discount// to its principal. * **Trading at a Premium:** Conversely, if interest rates fall, our bond’s fixed coupon looks more attractive. Its market price might rise to $1,050. It is now trading //at a premium//. These price swings are also influenced by the issuer's changing [[credit rating]] and general market sentiment. ===== A Value Investor's Perspective ===== ==== The 'Built-in' Gain: Buying at a Discount ==== For a value investor, the concept of buying a bond at a discount is particularly appealing. It creates a [[margin of safety]]. When you buy a bond below its principal value, you're setting yourself up for two types of returns: - The regular coupon payments. - A guaranteed capital gain at maturity. For example, you buy a stable company's $1,000 bond for just $950. You collect your interest payments over the bond's life. Then, at maturity, the company pays you the full $1,000 principal. You've just locked in a $50 gain on top of your interest income, simply by buying smartly. This is a classic value play—paying less for an asset than its intrinsic, guaranteed payback value. ==== Understanding the Risk of Premiums ==== Buying a bond at a premium isn't necessarily a bad move, but it requires careful calculation. If you pay $1,050 for that same $1,000 bond, you know you will experience a $50 capital loss at maturity. Often, such bonds offer a higher-than-average coupon rate that may compensate for this loss over time. The critical question is whether the extra income justifies the premium paid. To determine this, a savvy investor doesn't just look at the coupon; they calculate the bond's total return, or [[yield to maturity]], which accounts for the purchase price, coupon, principal, and time remaining until maturity.