Notional principal amount

The notional amount (or notional principal amount or notional value) on a financial instrument is the nominal or face amount that is used to calculate payments made on that instrument. This amount generally does not change and is thus referred to as .

Contrast a bond with an interest rate swap:

In simple terms the notional principal amount is essentially how much of the asset or bonds a person has. For example, if a premium bond was bought for £1 then the notional principal amount would be the face value amount of premium bond that your £1 was able to purchase. Hence the notional principal amount is the quantity of the assets and bonds.

In the context of an interest rate swap, the notional principal amount is the specified amount on which the exchanged interest payments are based; this could be 8000 US dollars, or 2.7 million pounds sterling, or any other combination of a number and a currency. Each period's rates are multiplied by the notional principal amount to determine the height and currency of each counter-party's payment. A notional principal amount is the amount used as a reference to calculate the amount of interest due on an 'interest only class' which is not entitled to any principal.

In a typical total return swap, one party pays a fixed or floating rate multiplied by a notional principal amount plus the depreciation, if any, in a notional amount of property in exchange for payments by the other party of the appreciation, if any, on the same notional amount of property. For example, assume the underlying property is the S&P 500 stock index. A would pay B LIBOR times a $100 notional amount plus depreciation, if any, on a $100 notional investment in the S&P 500 index. B would pay A the appreciation, if any, in the same notional S&P 500 investment.

Shares also have a notional principal amount but it is called nominal instead of notional.

If you are buying stock option contracts, for example, those contracts could potentially give you a lot more shares than you could control by buying shares outright. So the notional value is the value of what you control rather than the value of what you own.

So, for instance, if you purchase a 100 share equity call option with a strike of $60 for a stock that is currently trading at $60, then you have the same upside potential as someone who holds $6,000 of stock (1 option × 100 multiplier × $60), but you may have paid only $5/share (for a total of $500), so by this measure you have achieved leverage of $6,000/$500 = 12x. Note that if the stock price moves to $70, your dollar notional is now $7,000 (– cost of option and commission differential), but your quantity (unit notional) is still 1 contract.

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Wikipedia