What does it mean when a bond is sold at a discount to its par value?

When a bond is sold at a discount to its par value, it indicates that the yield of the bond exceeds its coupon rate. This situation occurs because the market demands a higher return for holding the bond than the fixed interest payments (coupon) it offers. Investors are willing to pay less than the par value to achieve a yield that compensates for the interest rates available on similar bonds in the market. This results in the bond being priced lower than its face value.

For example, if a bond has a par value of $1,000 and a coupon rate of 5%, but due to rising interest rates, investors can find new bonds offering 6%, the bond's price may drop below $1,000 to attract buyers. The difference between the purchase price and the par value is what allows the bondholder to earn a yield that reflects a rate higher than the original coupon.

Understanding this relationship is crucial for investors as it affects their return on investment and the bond's performance in varying interest rate environments.