Learn the specifics about what denomination means in certain contexts, and find out why it’s significant to your everyday personal finance and investing.
Definition and Example Denomination
Denomination refers to the face value of financial instruments such as currency, coins, bonds, and stocks. Cash is the most straightforward example of denominations in our everyday lives. The Federal Reserve Board issues the money in denominations of $1, $2, $5, $10, $20, $50, and $100 notes. The Department of the Treasury’s Mint issues coins in the denominations of a cent, nickel, dime, quarter, half-dollar, and dollar. While denominations stay the same, purchasing power doesn’t. Due to inflation, the purchasing power of a $10 bill, for example, is less than it was 10 years ago. The Treasury also denominates savings bonds. It sets the values for paper bonds at $50, $100, $200, $500, and $1,000, and electronic bonds at $25 and higher in penny increments.
How Does Denomination Work?
While it’s relatively easy to wrap your head around denominations concerning paper currency and coins, other areas where denomination comes into play are decidedly less intuitive. When a company issues stock, it sets a par value per share, which is similar to denomination. Often bound by state regulations and legal concerns and requirements, companies designate an arbitrary number for the par value of their common stock. Companies routinely set the par value for the stock they issue at or around $0.01. This sets a floor for the value of their stock in the market, which represents the minimum amount for which a company can sell its stock. For bonds, the issuer sets a denomination (face value) for the bond. Bonds can trade above or below par value based on multiple factors, mostly tied to market forces. Denominations play a role in international investing, too. “Dollar-denominated debt” and “dollar-denominated security or currency” refer to the instrument being issued in U.S. dollars.
Why It Matters to Individual Investors
Denomination matters in the everyday lives of individual investors because they offer convenience. For example, in years past, investors of modest means had fewer options for saving and investing their money. It used to be that savings accounts were one of the most attractive and only options, given their low minimum initial deposit or investment requirements; some banks were known as “dime” and “five-cents” savings banks because they accepted low denominations of deposits. Those days are gone, however. With the relatively recent removal of investment minimums for platforms such as online brokerage accounts, you can begin investing with much lower initial denominations, often as low as $1.00. For consumer spending, researchers have discovered what they call the “denomination effect.” When receiving money, consumers often opt for larger denominations over small ones when they feel the need to control their spending. In other words, it tends to be more difficult for people to part with larger cash denominations. A 2020 study in the journal Frontiers in Psychology showed that consumers were more likely to pay for a purchase with cash as opposed to credit when the cost of the purchase was the same as the denomination they had. From an investing standpoint, a 2009 Journal of Finance article presented the catering theory, which proposes that public companies often conduct stock splits to lure investors, because many investors find the lower denomination required to make the purchase more attractive relative to their perceived value of the shares. Along similar lines, investing became more accessible and potentially more attractive to some investors because of brokerages allowing investors to purchase fractional shares of stock. For example, one share of a $3,000 stock could make it an intimidating—if not impossible—investment for some investors. However, if you can enter the stock in a lower denomination—often as low as $1—via fractional shares, you can more realistically build a position in small denominations, maybe using dollar-cost averaging.
