Nominal value is a common financial term that is used in various contexts within finance. For stocks and bonds, it is also referred to as the “face value” of an investment that is stated on the front of a security. It is in contrast to the market value of a security.
In economics, the nominal value is the unadjusted value of an asset without taking into account deductions and premiums, such as expenses, taxes, and inflation. It is in contrast to the real value of an asset, which considers deductions and premiums.
Understanding Nominal Value
Nominal value is best explained as “what you see is what you get.” They are simplistic, easily comparable values that are viewed on a daily basis. Examples of nominal values include:
The examples above are all examples of nominal values since they are standalone quotes that are not relative to anything. In contrast, real value is more abstract; it is a value that is adjusted for some external factors, such as inflation.
Nominal Value vs. Market Value
When considering investments, such as stocks (equities) and bonds (fixed income), it is important to distinguish nominal value from market value. A nominal value for equities is usually the upfront price to purchase a security and remains constant.
A nominal value for fixed income is the par value of a security and also remains constant. The market value, on the other hand, is not constant. Market values are subject to fluctuations based on the supply and demand from investors for the securities.
Take, for example, a single stock of a company that is issued for $10. The nominal value is $10 and will not change. However, if the company suddenly secures a breakthrough investment and room for growth, many investors will want to buy the stocks of the company, driving up demand and subsequently, the market price.
Consider another example where a government issues a single bond with a face value of $1,000. The bond’s nominal value is $1,000 and will remain constant. However, if the economy is facing a recession, and investors are seeking safe investments, such as government bonds, the demand will be driven upwards and subsequently, the market price as well.
Nominal Value vs. Real Value
In economics, it is important to distinguish between the two. Nominal value is the upfront monetary value without adjusting for inflation, whereas, real value would reflect the actual value that would be realized.
It is an important consideration because some values may be skewed by the effects of inflation over time. Take, for example, a Treasury bond that yields 1% over one year. When adjusting for an inflation rate of 2%, the real return realized is actually –1%. In other words, the purchasing power of an investor that invested in the bond actually decreased.
Gross Domestic Product (GDP)
Gross Domestic Product (GDP) is the monetary value of goods and services produced in a country over a specific time period. GDP is very commonly used in economics as a measure of how well a country’s economy is functioning. A high GDP growth rate is a sign of a strong economy, and a low GDP growth rate is a sign of a slowing economy.
Nominal values apply to GDP as well. The nominal GDP of a country may indicate strong economic growth, but after adjusting for inflation, the real GDP may be much lower.
Nominal GDP reflects the growth of an economy simply from the increase in price levels, and increasing prices alone does not reflect a strong economy. However, real GDP holds prices constant to give a truer picture of an economy.
The Issue with Nominal Values
As mentioned earlier, nominal values are simplistic – easily comparable values that can be used to compare prices, investments, and various other monetary values. However, decision-makers should be wary of using nominal values to make decisions, as a nominal value does not accurately reflect what would actually be realized.
In making investment decisions, nominal value is irrelevant. Investments should be evaluated and compared ultimately on the real rate of return realized, considering taxes, inflation, and other costs are important in determining the optimal investment.
For example, you may be pleased to put money in a foreign investment that yields a 20% nominal annual return. However, when you consider the real return of that investment, you may not actually realize 20%.
For example, a foreign country may be experiencing very high inflation, which erodes the real value of your investment. Furthermore, the exchange rate of that foreign currency may be weakening from the high inflation, which further erodes the real value of the investment.