Why Bond Price Converges to Par Value at Maturity

Let’s explore why a bond’s price naturally moves closer and closer to its par value as it gets closer to its maturity date, assuming the company issuing the bond is financially sound and will not default on its obligations.

A bond’s price in the market can fluctuate after it’s issued, influenced by changes in interest rates and the perceived risk of the issuer. If interest rates in the broader economy rise after a bond is issued, newly issued bonds will likely offer higher interest rates, making older bonds with lower fixed rates less attractive. Conversely, if interest rates fall, older bonds with higher fixed rates become more appealing. This is why bond prices and interest rates generally move in opposite directions.

However, as a bond approaches its maturity date, the impact of these fluctuating market interest rates diminishes. Why? Because the bond is essentially a contract to pay the bondholder the par value at maturity. Imagine you have a bond that matures in 30 years. A lot can change in 30 years, and the present value of that future par value payment is significantly affected by current interest rates and uncertainty about the distant future. But, if that same bond only has one month left until maturity, the payment of par value is just around the corner. The uncertainty about the distant future is gone. The primary factor determining its price becomes the near-certainty of receiving that par value very soon.

Think of it like this: the bond’s price is always trying to balance two main forces. One is the present value of all future cash flows from the bond, meaning the coupon payments and the final par value repayment. The other force is prevailing market interest rates, which determine the attractiveness of the bond compared to other investments.

As maturity nears, the number of future coupon payments shrinks, and the largest remaining cash flow becomes the par value repayment at maturity. The present value calculation becomes dominated by this almost immediate, guaranteed payment. The influence of broader market interest rate fluctuations becomes less and less significant because there’s very little time left for interest rate changes to impact the bond’s overall return between now and maturity.

Essentially, a bond at maturity is just a promise to pay par value, and that promise is about to be fulfilled imminently. The market price, reflecting the perceived value of that promise, will therefore converge towards the actual amount promised, the par value. By the time the bond matures, its market price should be virtually identical to its par value. This is because on the maturity date, the issuer will pay you the par value. There’s no more uncertainty, no more future coupon payments, just the final repayment of principal. The bond has fulfilled its purpose, and its price reflects that certainty.

This convergence is a fundamental characteristic of bonds and is a key reason why understanding maturity dates is crucial for bond investors. It’s a predictable and reliable aspect of bond behavior, assuming the issuer remains creditworthy.