Overview
Nominal value of a security, often called face or par value, represents the redemption price and is typically noted on the security’s front. For bonds and stocks, it’s the issued security’s stated value, different from its market value. In economic terms, nominal values are the unadjusted current prices, excluding inflation adjustments and other factors, unlike real values where adjustments for general price level changes over time occur.
The Significance of Nominal Values
Nominal value is pivotal in many calculations for bonds and preferred stocks, impacting interest payments, market values, discounts, premiums, and yields. Generally, the nominal value of common stocks remains lower than their market value due to supply and demand influences. For preferred stocks, nominal values align closer to market values. For bonds, the nominal or face value will differ from market value, dictated by the market interest rates.
Both economic and financial analyses differentiate between nominal and real values. Nominal GDP contrasts with real GDP, and so do nominal interest rates against real interest rates. Real values consider purchasing power changes, providing a more accurate picture. Nominal rates of return are the actual earnings as an investment percentage, whereas real rates adjust for inflation, reflecting the real purchasing power of earnings.
Key Takeaways
- Nominal Value of Securities: It refers to the redemption price of a security, usually noted on its front.
- Bonds’ Nominal Value: The face value of bonds varies from market value based on prevailing interest rates.
- Preferred Stock: The nominal value is crucial for calculating dividends, while common stock nominal values serve for balance sheet purposes.
- Economics Context: Nominal values represent current monetary worth, without gauging inflationary impacts.
Nominal Value of Bonds
For bonds, the nominal value—also known as the face value—is the repaid amount to the bondholder upon maturity. Common nominal values are $1,000 for corporate bonds, $5,000 for municipal bonds, and $10,000 for government bonds.
If a bond’s yield to maturity (YTM) exceeds its nominal interest rate (coupon rate), the bond trades below its face value, i.e., at a discount. Conversely, if YTM is below the nominal rate, the bond trades above face value, at a premium. When YTM and coupon rate are equal, the bond trades at par value. Zero-coupon bonds always sell at a discount because interest isn’t disbursed until maturity.
The formula for bond market value is:
$$ \text{BP} = \sum \left( \frac{\text{Coupon Payments}}{(1+\text{Market Yield})^i}\right) + \left(\frac{\text{Face Value}}{(1+\text{Market Yield})^n} \right) $$
Where:
- BP = Bond price
- Coupon Payments = Face value × Coupon rate
- i = Each year
- n = Number of years
Example Calculation
For a corporate bond, face value $1,000, and a 10% coupon rate over three years:
If the market rate (YTM) is 12%, the market value would be:
$$ \begin{aligned} &\text{Bond Price} = \frac{$100}{1+0.12} + \frac{$100}{(1+0.12)^2} + \frac{$100}{(1+0.12)^3} + \frac{$1000}{(1+0.12)^3} \ &= $89.29 + $79.72 + $71.18 + $711.79 = $951.98 \end{aligned} $$
Nominal Value of Stocks
A company’s stock nominal value, or par value, is an arbitrary figure assigned for balance sheet purposes during stock issuance, usually $1 or less. It does not influence the stock’s market price greatly. For instance, a company issuing $5 million in shares at a $1 par value can sell up to 5 million shares. The difference between par and sales price forms the share premium.
For preferred stocks, the nominal value is critical as it determines dividends. A 5% preferred stock with a $50 nominal value pays $2.50 per share annually in dividends. Market perception of the dividend rate influences the preferred stock’s price. If the 5% rate satisfies the market, the stock trades around its nominal value. Higher or lower market expectations result in prices deviating from nominal value.
Nominal Value in Economics
In economics, nominal values represent present monetary values, absent inflation considerations, potentially reducing their utility for time-based comparisons. Therefore, real values, inflation-adjusted, offer comparatives better suited for analysis. The real interest rate is the nominal rate adjusted for inflation:
$$ \text{Real Rate} = \text{Nominal Rate} - \text{Inflation Rate} $$
Example
With a 5.5% nominal GDP growth and a 2% inflation rate, the real GDP growth is 3.5%.
Nominal vs. Real Exchange Rates
The nominal exchange rate is the domestic currency unit’s purchasing power against foreign ones. Unlike it, the real exchange rate accounts for domestic versus foreign price levels adjusted by the nominal rate. Even with fixed exchange rates, the real rate fluctuates with inflation changes.
For export competitiveness assessments, the real exchange rate is crucial. The nominal effective exchange rate (NEER) and the real effective exchange rate (REER) serve as indicators of international competitiveness in the forex market, with NEER adjusted for inflation forming REER.
Related Terms: face value, par value, redemption price, market value, real value.
