When it comes to investing in bonds or securities, many terms can be confusing. One such term is the "nominal value" of a bond or security. The Dallas Federal Reserve defines the nominal value as "the value of an economic variable in terms of price level at the time of its measurement; or unadjusted for price movements." In short, it's the face value of a bond or security. Nominal value is often compared with "real value," which does fluctuate with factors such as inflation.
Find the real value of the investment vehicle. The real value refers to the value after the item has been adjusted for factors such as inflation. For this example, assume the real value of a bond is £1,300.
Locate the price index associated with the real value of the investment vehicle. A price index is a measure of relative changes over the course of time. To derive a real value, it must be compared with an associated price index. For the example above, assume the £1,300 bond was associated with a price index of 200. This would mean that a bond had moved 200 per cent according to the price index data. (Price indexes are in percentage form.) To illustrate this point away from the bond world, think of someone comparing the value of his house (real value) against the percentage that home prices have risen or fallen in the area (price index). Comparing those two would help you find the nominal value, or price of the home when it was purchased without fluctuations.
Divide the price index by 100. In this example, you would divide 200 by 100. The 100 represents 100 per cent of the bond value. This would leave you with an answer of 2. Call this the "factor," as it is the factor by which the price changed.
Divide the real value by the factor to get the nominal value. In this example, £1,300 / 2 = £650. This means that the original nominal value of the bond was £650 before the rise in cost to its real value.
The formula for real value: Nominal Value / Price Index = Real Value The formula for nominal value: Real Value / (Price Index / 100) = Nominal Value
Tips and warnings
- The formula for real value:
- Nominal Value / Price Index = Real Value
- The formula for nominal value:
- Real Value / (Price Index / 100) = Nominal Value