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What is Nominal Value of a Bond?
The nominal value of a bond is its value at maturity. A US Treasury bond, for example, comes in denominations of multiples of $ 1,000. The nominal value appears in the same bond (hence the alternative term “nominal value”). But bonds will have a market value equal to its nominal value only in the date of expiration.
The market value of the bond, even at the time of issuance, is equal to its price in the open market. This value depends on several different economic and market conditions.
An investor can buy a 10 Year US Treasury bond at auction. The US government regularly conducts auctions of government debts like Treasury bond (T-Bond), Treasury notes and Treasury Debt Bonds. These are all bonds for historical reasons. The Government refers to a bond of 10 years as “promissory note”.
Investors refer to all of them collectively as “Treasury bonds”. An investor can buy a 10 year treasury bond in one of these auctions. The 10-year bond with a value of US $ 10,000 will have a value at maturity of $ 10,000, which is its nominal value. The bonus comes with an interest rate of say 3.25 percent. This means that every year the government will pay the bond holder 3.25 percent of its nominal value. In this case the annual interest payment will be equal to $ 325.
Factors affecting the Price of Bonds
The following are some of the factors that affect the price of bonds
1. The price of a bond is based on demand
The actual price that the investor will pay for a Treasury bond at the time of issuance depends on the demand of investors. In early 2010, investors, particularly the government of China, became uncomfortable with the increasing debt of USA. The demand for 10-year bonds became weakened. The auction price for the benchmark 10-year US $ 10,000 issued on February 16, 2010, equaled 99.442944 percent of its nominal value, or $ 9,944.29. The interest rate equaled 3.625 percent.
2. External events influence the value of the bond:
During the early May of 2010 in Europe a dreadful debt crisis had begun. Investors fled to overseas markets to seek the relative safety of US government debt. The benchmark 10-year US $ 10,000, auctioned on May 17, 2010, was sold for 99.5987 percent of its nominal value, or $ 9959.87, US $ 15.78 more than the bond auction in February. More interestingly, the interest rate on the bond May equaled only 3.5%, a fall of one eighth of February’s rate. The events in Europe increased the demand for bond of June. As a result, the US government could only sell the bond with a lower interest compared to the previous one.
3. Inflation and interest rates affect price of bond
Inflation and deflation also affect interest rates offered by the Treasury. In 1965 the average inflation rate of US was around 1.5 percent. The 1 year treasuries bond auctioned in 1965 averaged about 4 percent. In 1974 the US had experienced a period of high inflation. The average inflation rate was around 11 percent. The rates of tender for 1 year treasury bonds in 1974 were on average at 8 percent. In times of higher inflation, investors always demand for higher returns.
4. Inflation rates affect market value of bonds
As inflation increases, interest rates of treasury bonds auctioned also rise. The values of the treasury market decreases with lower interest rates, since they offer comparatively lower yields. On the contrary, if inflation decreases, interest rates of treasury bonds decrease. This raises the value of treasury bond with higher interest rates. This volatility increases during the bond period and decreases as their expiry dates approach.