What is Face Value?
Face value is the dollar amount shown by words and/or numbers on a financial document. It’s particularly common in bonds and life insurance policies. Understanding face value helps you navigate the complexities of financial instruments and makes you more informed about your investments.
Why Face Value Matters
The face value of a financial document has far-reaching implications for both investors and issuers. It determines the amount to be received at maturity for bonds and is principal when amortizing mortgages.
Example of Face Value in a Mortgage
Let’s consider an example for better understanding:
- Mortgage Details:
- Face Value: $100,000
- Amortization Term: 30 years
- Face Interest Rate: 6%
Over 12 years, the mortgage will be amortized down to a remaining balance of $79,079.
Breakdown:
Here’s a simplified breakdown on how payments reduce the remaining balance:
- Initial Years: Higher interest payments; lower principal payments.
- Later Years: Lower interest payments; higher principal payments.
Comparison with Market Value
- Face Value: The original amount stated on the document.
- Market Value: The actual trading price in the financial markets. This could be higher, lower, or equal to the face value, depending on various factors such as market conditions and issuer’s creditworthiness.
Amortization and Face Value
In fixed-income securities like mortgages, face value is key in calculating amortization. Amortization refers to the process of spreading out a loan into a series of fixed payments over time. This impacts both the interest and the principal amounts of the payments.
Conclusion
Understanding the concept of face value is crucial for anyone dealing with financial instruments. It provides a basis for calculating repayments, interest, and evaluating the worth of investments. Always compare face value with market value to get a deeper understanding of your financial standing.
Frequently Asked Questions (FAQ)
What is the difference between face value and market value?
Face Value is the original stated value of the financial document, whereas Market Value is the amount that the instrument is currently worth in the financial market.
How is the face value of a bond determined?
The face value of a bond is determined at issuance and represents the principal that will be returned to the bondholder at maturity.
Does the interest rate affect the face value?
The interest rate does not affect the face value directly but impacts the payments made during the amortization of financial documents like mortgages.
Can the face value change?
The face value typically remains constant over the life of the financial instrument, unless there are special adjustments or stipulations in the agreement.
What happens when the mortgage balance falls below its face value?
When a mortgage’s balance falls below its face value through amortization, it means the borrower has made principal payments reducing the amount they owe on the loan.
Related Terms: Market Value, Amortization, Principal, Nominal Value.
