What is Face Value?
Face value, also known as par value, is the dollar value of a financial instrument established by the issuer. It represents the redemption amount that will be paid to the holder when the instrument reaches maturity. Face value is an anchor for determining interest payments, discounts, and benchmarking prices.
The current face value meaning derives from the price written on the ‘face’ of the physical document representing a stock or bond issued by a company or government. These instruments were sold in paper decades ago when electronic systems did not exist.
The face value represents the legal monetary worth promised by the issuers of financial instruments and securities rather than their current price at which the asset can be sold in the secondary market.
It serves as a reference point to determine how much money the investor will receive via interest payments and upon maturity. It also represents the amount the issuer owes and has promised to repay to the person or institution holding the asset.
What is the Face Value of a Bond?
The bond’s face value or par value represents the amount that the issuer will repay bondholders when the instrument matures. The most common denomination is $1,000. However, some corporate and municipal bonds have face values of $5,000 or higher.
A bond’s coupon or interest rate is calculated based on a percentage of the face value. For a $1,000 bond with a 5% coupon, the annual interest payment would equal $50. Zero-coupon bonds do not make interest payments. Instead, they trade at a face value discount and repay the face value at maturity.
Face value should not be confused with market price, which fluctuates depending on factors like prevailing interest rates, maturity date, and the issuer’s credit rating.
Higher interest rates mean lower prices and broader discounts to face value. Lower interest rates mean higher prices and slimmer discounts.
Importance for Secondary Market Trading
On secondary exchanges, the face value is used as a reference to establish if a bond is trading sub or above ‘par’. Bonds trading above their face value are referred to as being sold at a premium while those sold below their face value are offered at a discount.
As maturity approaches, prices generally converge toward face value since that is the amount the bondholder will receive on the maturity date of the financial instrument.
What is the Face Value of a Stock?
For common stocks, the face value definition changes to the par value of a company’s common shares as designated in its articles of association. The par value represents the legally required minimum paid-in capital per share a company must charge for every share it sells to investors. Most states mandate that shares cannot be issued and sold below par value.
Par values for common shares are typically set at extremely low levels like $0.01, $0.001, or even $0.0001 per share. This allows directors that, even if the market price of the shares declines sharply, they can still sell additional equity at low prices – even below $1 in some cases – to raise the required financing without running into legal issues.
Consequently, par value has almost no relation to the actual market value at which common stocks trade. Proper regulatory filings allow the par value to be increased or decreased if needed.
For preferred shares, the face value holds greater economic significance. The par value helps determine the dividend payments for preferred shareholders, usually specified as a percentage of the face amount.
For example, a preferred share with a face value of $100 carrying a 5% annual dividend would result in an annual dividend of $5.
What is the Face Value of Life Insurance?
A life insurance policy’s face value or death benefit represents the amount that the beneficiaries will receive if the insured passes away while coverage is active. Higher face values require greater premium costs to offset the larger payout that is on the table.
Insurance companies providing additional payouts for accidental death, disability, terminal illness, and other conditions can increase the total death benefit above the face value.
Loans and withdrawals during the insured’s lifetime can decrease the face value of the policy. Insurers also establish an age boundary after which the face value declines gradually as the likelihood of death increases due to natural aging.
Face Value vs. Surrender Value
Many life insurance plans build up a cash surrender value separate from the face value of the death benefit. If the customer decides to cancel a policy or the contract is extinguished for some reason, insurers usually pay out the surrender value rather than the face value of the policy.
It starts out lower than face value but accumulates over time through premium payments and accrued interest.
Face Value vs. Par Value
For bonds, the terms face value and par value are synonymous, referring to the amount that will be repaid at maturity as denoted on the bond’s certificate.
For equities, par value refers specifically to the dollar figure set per share in a company’s charter below which share units cannot be sold to investors. However, par values are set so low that they have little use in financial analysis or trading decisions.
Importance of Face Value
- Face value creates uniformity when assessing the price of bonds across different issues by anchoring their coupon rates and redemption promises.
- It also creates standardization in calculating insurance payouts, regardless of individually varying premiums costs and cash surrender buildups.
- Specifying face values makes it simpler to compare the financial characteristics of instruments both within and across different asset classes. The dollar amount denoted makes the instruments fungible. Relative valuation would become much more complex without the single fixed reference point of face value.
Face Value in Accounting and Financial Statements
In a company’s balance sheets, the equity share capital account denotes the total face value of outstanding common and preferred shares based on their respective par values. It represents shareholders’ capital contributions at par value rather than current market values.
However, since most companies sell their shares above this face value, an account named ‘capital paid in excess’ expresses how much money the company has managed to raise from investors by selling its common and preferred shares above their legal par value.
Meanwhile, all debt issued in the form of bonds is accounted for by companies and organizations based on their face value unless there are reasonable grounds to believe that the instruments can be repurchased from investors at a lower price and the organization intends to do so on short notice.
In contrast, for institutional investors, bonds are considered assets, and their value fluctuates occasionally depending on market conditions.
The accounting value of these bonds needs to be periodically assessed and any meaningful changes must be reflected in the corresponding accounts to ensure the balance sheet accurately portrays the organization’s financial situation.
Face Value vs. Market Value
While face value represents what issuers promise to pay investors at maturity or redemption, the market value denotes how much these instruments would be worth if they were sold to another investor right now. The market sets these real-time prices based on supply and demand dynamics.
In most cases, the face value remains fixed over the lifespan of the instruments while their market value fluctuates based on the business’s performance, economic forces, investors’ risk appetite, and changes in benchmark interest rates.
Since market participants take into consideration all of these factors to determine the value of a bond, market prices tend to diverge significantly from face values in some cases, at least until the instruments come near their maturity date, at which point the market value tends to converge with the face value.
For common stocks, market values rarely approach the face value as the latter is usually a symbolic and negligible amount that has no use aside from complying with certain legal stipulations.