Face value represents the nominal value of an asset. For example, the face value of money is set by the federal government and printed directly on it, so it’s easy to identify. In the investment industry, face value typically involves the value of securities, such as stocks and bonds.
Market value, or the value an asset is selling for in the market, is another thing altogether. As an investor, it’s important to understand what face value is and how it compares to market value. This article delves deeper into what face value is regarding stocks, bonds and life insurance and how it differs from the market value.
Defining face value
In the financial industry, face value represents the value, in dollars, of a specific security, such as stocks and bonds, at the time it's issued. Just like the federal government sets the face value, the issuers of stocks and bonds set the value of the securities it offers. While the market rate for these assets may fluctuate based on various factors, such as supply and demand, the face value remains constant.
It’s important for investors, especially new investors, to understand how face value relates to stocks and bonds and how it differs from market value. Face value can help investors better compare stock and bond options and assess profits.
Face value in bonds
The government and many corporations use bonds to build capital for special programs or growth projects. Each bond comes with a set term that typically ranges from 1 to 10 years or more. The face value of each bond, also referred to as the par value or redemption value, is set by the issuer and typically printed on the bond itself. It represents the amount the issuer promises to pay once the bond reaches maturity. The face value remains static throughout its duration, with the exception of inflation-linked bonds, which can have fluctuating face values.
Interest rates on bonds are typically based on a percentage of the face value and expressed as a coupon rate. For example, the interest payment for a $5,000 bond with a coupon rate of 5% is $250 ($5,000 * .05). These interest rates directly impact the market value of the bond.
When interest rates are higher than the bond coupon rate, it’s referred to as below par and the bond is sold at a discount. When interest rates are lower than the bond coupon rate, it’s referred to as above par and the bond is sold at a premium. When deciding which bonds to invest in, it’s important to compare current interest rates with the bond coupon rate.
Face value in stocks
The face value of stocks represents the value a company assigns to its shares. Some companies set a nominal face value, such as $0 or $1, to add extra protection for their shareholders in case the stock were to tumble.
In most cases, the face value remains stable. However, if the company decides to conduct a stock split, it could lower the face value. For example, if ABC Company sets the face value of its stock at $10 per share and then later decides to split the shares in two, the value of each share decreases to $5 per share.
The face value also comes into play when it's time to calculate dividends. For example, when calculating the annual preferred stock dividends, you divide the dividend percentage by the par value of the preferred stock. Let’s say that you own 100 shares of stock with a face value of $25. If the dividend percentage is 5%, the annual preferred stock dividend is $1.25 per share (5/100*25).
Face value vs. market value
As mentioned above, the face value of a security represents the dollar value the issuer gives to the security when it’s initially issued. Typically, this value remains stagnant over the lifespan of the security.
On the other hand, the market value represents the price that an investor agrees to purchase and the issuer agrees to sell a specific security. This value often fluctuates significantly based on various factors, such as supply and demand and current interest rates.
The reality is that there is very little correlation between face value and market value. It’s still important to identify the face value of a security when comparing your stock and bond options. With this information, you can assess the stock’s current market, rate of interest and profit potential.
What is the face value of life insurance?
Many people purchase life insurance to provide financial security to their loved ones in the event of their death. Beneficiaries can use these policies to pay for end-of-life expenses or to cover other costs. The face value of a life insurance policy, often referred to as the death benefit, is the amount paid out to the beneficiaries upon the death of the policy owner. The death benefit value also directly relates to the cost of the policy.
The face value of a life insurance policy can change over time. For example, you can purchase additional insurance, also called paid-up insurance, that can add to the face value. Additionally, some insurance policies come with riders that may change the payout amount. For instance, policies with a double indemnity clause pay double the face value of the policy if the death results from certain types of accidents, such as a car accident.
Some life insurance policies also have a cash value element. If this is the case, you may be able to take out a loan against this cash value. It’s important to note that if you do take a loan out against your policy, it reduces the death benefit that your beneficiaries would receive in the event of your death. With this type of policy, you can also surrender your life insurance policy at any time for the cash value amount, minus any loan amounts taken out.
Face value vs. par value
Face value and par value are technically the same terms. When comparing a bond's face value with its market value, investors often use the term par. If interest rates are higher than the coupon rate of the bond, it’s considered being sold below par, or at a discount. On the other hand, if the interest rates are lower than the coupon rate of the bond, it’s sold at a premium or above par. This correlation doesn’t hold true for stocks because shares cannot be sold below par value.
Our take
While face value doesn’t reflect actual market value for stocks and bonds, it can be useful data when comparing various investment options. When purchasing life insurance, however, face value impacts your premiums and how much your loved one can receive in death benefits.
