Nominal Value – Meaning, Calculation & Examples
Have you ever wondered about the intriguing world of nominal values in the stock market? Well, you’re in for a treat!
Nominal values of shares, sometimes called par value or face value, play a fascinating role in the stock market’s foundation. They represent the minimum price at which shares can be traded. When a company is born, and their significance goes beyond just accounting.
What is Nominal Value?
In finance, we often encounter the term ‘nominal value,’ or ‘face’ or ‘par value’, especially when dealing with stocks and bonds. This is the face value of an investment, boldly stated on the front of a security, setting it apart from its market value.
In the realm of economics, nominal value represents an asset’s unadjusted worth. It is free from deductions or premiums like expenses, taxes, or inflation. It’s distinct from an asset’s real value, which factors in those deductions and premiums.
Exploring the Nominal Value of Shares Meaning
In finance, nominal value is crucial for bond and preferred stock calculations. It also encompasses interest payments, market values, discounts, premiums, and yields. Common stock typically holds a much lower nominal value compared to its market value due to supply and demand factors. On the other hand, preferred stock’s nominal value usually aligns more closely with its market value. For bonds, the this value deviates from the market value based on prevailing interest rates.
In economics, nominal and real values have significant roles. This extends from comparing nominal GDP to real GDP to evaluating nominal interest rates versus real interest rates. Real values factor in changes in purchasing power, accounting for inflation and the actual buying power of an investor’s earnings. While the nominal rate of return represents an investor’s earnings as a percentage of their initial investment, the real rate of return considers inflation’s impact on the investor’s purchasing power.
How is Nominal Value Calculated?
To calculate the nominal value of a share, shareholders need to consider the total number of shares issued by the company. Simply divide the total share capital by the determined number of shares. This calculation is crucial as it determines the dividends shareholders receive based on their share ownership.
In summary, the formula for nominal share value is straightforward. It derives by dividing the paid-up share capital by the outstanding number of shares of the company.
Nominal Value of Shares = Paid-up Share Capital / Number of Outstanding Shares
Example: If a company has an authorized share capital of ₹500,000 and is authorized to issue 100,000 shares:
Nominal Value of a Share: ₹500,000 / 100,000 = ₹5
However, it’s important to understand that the face value doesn’t reflect the market value or actual worth of the shares. It primarily serves as an accounting figure.
Market Value of a Share
The market value of shares represents the price at which securities are traded on a stock exchange. It reflects the buying and selling prices for shares and bonds in the stock market.
The stock market value is influenced by the demand for these shares, which is driven by the company’s overall performance and growth prospects. When determining market capitalization, the market value of all equity shares issued by a company is considered, providing insight into the company’s relative size in the market.
The Difference Between Nominal Value and Market Value of Shares
Here is a table of the differences between Nominal Value and Market Value.
| Points of Difference | Nominal Value | Market Value |
| Definition | The nominal value of a share is its original issuance value or the value stated on the face of the share certificate. It represents the stated worth of a share when the company is initially established. | The market value represents the current trading price of a share in the stock market. Investors assess it based on the company’s performance, growth potential, and various market factors. |
| Purpose | Companies rely on nominal value to establish their legal capital, typically not issuing shares below this value. | It mirrors the company’s current stock market valuation, constantly fluctuating as shares are bought and sold throughout trading hours. |
| Changes | This value remains unchanged unless a corporate action, such as a stock split, occurs. | Market value changes according to supply and demand dynamics, news, company performance, broader economic factors, and investor sentiment. |
| Usage | It doesn’t significantly impact a stock’s market performance; its primary importance lies in accounting and legal contexts. | Investors find it to be a crucial metric as it offers insights into the market’s perception of a company’s current value. |
The Difference between Nominal Value and Real Value of Shares
The nominal exchange rate represents how many units of the domestic currency are needed to buy one unit of a foreign currency. On the other hand, the real exchange rate compares the foreign and domestic price levels, considering inflation.
It’s important for assessing export competitiveness. The nominal effective exchange rate (NEER) provides insight into a country’s forex competitiveness, but the real effective exchange rate (REER) adjusts for inflation differences between the home country and its trading partners.
Nominal Value of Bonds
Understanding the concept of nominal value in stock shares is relatively straightforward. However, when it comes to bonds, the this value becomes a bit more intricate.
The face value of a bond represents the precise accounting amount credited when it’s issued. This sum is then divided into smaller coupons, forming the bond’s par value. These smaller units facilitate trading in the market.
In the bond market, the nominal value serves another purpose—it helps determine the bond’s interest rate. Consequently, taking into account various factors like supply, demand, and issuance, the account manager can calculate the final redemption amount, moving from the par value to the principal.
Nominal Capital
Nominal capital, often referred to as authorized capital or registered capital, represents the highest amount of share capital a company is permitted to offer to its shareholders, as defined in its charter or articles of association. This value is termed “nominal” because it doesn’t necessarily correspond to the actual capital the company has raised from shareholders. Instead, it represents the maximum limit for capital acquisition through share issuance.
Nominal capital is divided into shares with a fixed nominal value, also known as par value. The company can choose to issue some or all of these shares to generate capital. The segment of nominal capital that has been provided to shareholders in exchange for cash or other assets is known as issued capital.
Why Investors Cannot Depend on Nominal Value to Make Investment Decisions?
As mentioned earlier, nominal values are straightforward and easily comparable figures used for comparing prices, investments, and various monetary values. However, it’s important for decision-makers to exercise caution when using nominal values for decision-making, as they do not accurately represent the actual outcomes.
In the context of investment decisions, nominal value holds little relevance. The evaluation and comparison of investments should primarily consider the real rate of return, factoring in elements like taxes, inflation, and other associated costs that are critical for determining the optimal investment.
For instance, you might be enticed by a foreign investment offering a nominal annual return of 20%. But when you factor in the real return of that investment, you might not actually realize a 20% return.
To illustrate, a foreign country experiencing high inflation could diminish the real value of your investment. Moreover, the weakening exchange rate of that foreign currency, influenced by the high inflation, would further erode the real value of your investment.
To Wrap It Up…
In conclusion, understanding nominal values is essential for navigating the financial world. While they provide a simplified basis for comparison and analysis, it’s crucial to remember that nominal values don’t tell the whole story. Real-world factors like inflation, taxes, and currency fluctuations can significantly impact the actual value of investments and purchases.
As savvy investors and consumers, we should look beyond nominal values and focus on the real returns and costs that shape our financial decisions. By doing so, we can make more informed choices and secure a stronger financial future.
FAQs
In finance, we often encounter the term ‘nominal value,’ especially when dealing with stocks and bonds. This is the face value of an investment, boldly stated on the front of a security, setting it apart from its market value.
The nominal value represents how many units of the domestic currency are needed to buy one unit of a foreign currency. On the other hand, the true value compares the foreign and domestic price levels, considering inflation.
If a company has an authorized share capital of ₹500,000 and is authorized to issue 100,000 shares:
Nominal Value of a Share: ₹500,000 / 100,000 = ₹5
Nominal values play a crucial role in the economy by indicating the current price of a good. For instance, when someone sells a lawnmower, they must determine its par prices or its current market value. This information is vital for various economic transactions.
