Par yield, also referred to as the par rate, is when the coupon rate and the yield of a bond are equal and the bond price will be the same as its nominal value, also called its par value. The par value is the payment made to a bond investor at maturity, and the coupon rate is the annual interest rate that he or she receives. The yield, or yield to maturity (YTM), is normally the estimate of the average return on a bond investment if the bond is not sold before it matures. The YTM is required to calculate all future payments in present terms. Par yield can happen because a bond can be priced at par, below par or above par, and when the bond is at par, the yield and coupon rate will be the same.
Similarly to many other instruments in finance, bond prices and yields rise and fall as a result of many factors that influence supply and demand. One has to remember, however, that bond yields and prices have an inherent inverse relationship; in other words, at the rise of bond prices, for example, bond yields will drop, and vice versa. For instance, if a bond is priced above par, it usually will have a coupon rate that is higher than the yield. Theoretically, the yield will have to rise to prompt a drop in the price until the price reaches par value. At the same time, the coupon rate and yield will be equal, and one would have what is called par yield.
When bonds are quoted at the market, among other particulars, they will show the coupon rate, the bond price and the yield. To illustrate the point of a bond with a par yield, one might consider use a hypothetical example. A bond might be priced above par at 103.31 and might have a coupon rate of 5.75 and a yield of 4.74. An upward move in the yield, which then eventually reaches the level of the coupon rate at 5.75, will drive the bond price down to par or 100, and then a par yield would have been attained. Otherwise, the price will be the one to decline to reach par while spawning an upsurge in the yield until it equals the coupon rate.
In practice, it is rare to encounter a bond trading precisely at par. Some bonds will trade very near to par, between 99 to 101, for example. When bonds are trading between these two values, they are considered to be more or less at par.
A type of bond called a zero-coupon bond is a good example of a bond that is sold at a discount or below par. Unlike many other bonds, this type does not pay any coupons to the holder between the purchase day and maturity. When it matures, the investor will receive the par value, which can allow him or her to realize a profit from the difference of the discounted price and the par value.
