Introduction
Above par is a way of describing a bond's price when it trads above its face value. Generally,a bond trades at the above par when its returns are greater than those of other bonds presently available on the market. It happens because interest rates have fallen in such a way that newly issued bonds bear lower coupon rates.
Understanding Above Par
The main reason for the opposite relationship is that a current bond yield must suit the yield of a new bond issued in a market with high or low-interest rates that exist. An investor purchasing a bond which is trading over par will earn higher interest payments. That's because the coupon rate was established in a market of higher existing interest rates. If the bond is taxable, the buyer may choose to offset taxable interest income by amortizing the bond premium. Unless the bond yields tax-exempt interest, the lender must amortize the premium under IRS law.
The above par movement for a non-callable bond is contingent on the duration of the bond. The longer the duration, the greater the sensitivity to interest-rate changes. On the other hand, the price increase above par is limited because when interest rates fall for a callable bond, the borrower will very likely be repaid by it. The issuer would leave those old bonds and reissue lower-coupon new bonds.
You must know the following factors:
- In the bond market, par is the bond's face value. That is the amount that the bond issuer will pay to the bondholder when the bond matures.
- This happens when interest rates have declined, and the newly issued bonds carry lower coupon rates.
- An investor purchasing a bond priced over par would receive higher interest payments because the coupon rate has been set in a higher prevailing interest rate environment.
