What is Pull to Par?

Last Updated: 30 Jun 2022

Almost every experienced investor diversifies and invests in various asset classes. Although they may start with equities, they do not retrain their investments to trade in stocks. as a bear market can wipe out a major chunk of the investments value. One of the most widely invested asset classes for diversification is Bonds. bonds allow investors to receive a regular interest payment with the promise of repayment of the principal amount. However, as bonds are complex, it is important to understand the factors that affect their structure and returns. One such factor is Par to Pull.

What are Bonds, and how do they work?

Bonds are loan agreements between the issuer and holder, which details the terms of payment (debt servicing) and maturity. These come with a face value (principal) to be repaid on maturity and can be issued either at a discount or a premium. Bonds are fixed tenure debt instruments issued to finance specific projects by the issuer. The interest (based on coupon rate) is paid in pre-defined instalments to the bondholder until maturity. Bond prices are inversely proportional to market interest rates and depend on various factors such as the issuer’s credibility, maturity, and interest rates in the market. Bondholders are free to buy new bonds or sell the bonds they are holding anytime before expiration.

What is Pull to Par?

Pull to Par is a term used to describe the movement of a bond’s price towards its actual face value with every passing day till its maturity. The principle of pull to par is based on the principle of face value, which is the amount that is paid to the bondholder by the issuer at the date of maturity. As per pull to par, bonds that are trading at a premium (over the face value or par) decrease in price as they approach the maturity date. However, bonds that are trading at a discount (below the face value or par) increase in price as the maturity date nears.

Understanding Pull to Par: Discount Bonds and Premium Bonds

An investor looking to buy bonds can do so from the secondary market at par, a premium or a discount. When an investor buys the bond at par, it means that the bonds are purchased at face value. This face value is the amount that the bondholder is entitled to receive on the day of maturity. If the bondholder holds the bond purchased at par until maturity, the only profit will be the interest amount as the principal amount they invested will be repaid in full by the issuer.

However, if the bond is purchased at a discount or premium, there is a negative or positive gap between the actual price and the par value of the bonds. A bond purchased lower or higher than the par value tends to be pulled higher or lower, respectively, as the time to maturity looms closer. This tendency of the bond coming closer at price to the par value is known as pull to par. For example, if a bond is issued for Rs 800 with a one-year maturity and par value of Rs 1,000, it will gradually increase in price from Rs 800 to Rs 1000 over 12 months. This movement of a bond gradually reaching its par value, whether increasing from discount or decreasing from premium, is the pull to par effect in bonds.

Final Word

Investing in bonds is an effective way to ensure a regular stream of income without losing the value of the principal amount. The pull to par effect in bonds is vital for the bond to inch closer to the par value and let the investor understand how much the bond is valued at the time of maturity. Now that you have understood the pull to par definition, you can invest smartly in bonds.

Frequently Asked Questions

1. How do you calculate pull to par?

The formula for calculating pull to par is: pn=100/(1+y)n≈100×(1−ny)

2. Why does a bond pull to par?

All bonds pull to par as the bondholders inch closer to receiving the face value (principal amount) as the bond’s maturity nears.