What Is Notional Value?

Notional value is a term often used to value the underlying asset in a derivatives trade. It can be the total value of a position, how much value a place controls, or an agreed-upon amount in a contract. This term is used when describing derivative contracts in the options, futures, and currency markets.

Notional Value vs. Market Value

The concept of notional value must not be confused with the idea of market value. Although both terms describe the value of financial security, the images are used in different contexts.

Notional value is the total value of a position in financial security. Strictly speaking, it determines how much money a place in securities control. In other words, the value can be viewed as a theoretical value of a position in securities.

Conversely, the market value indicates the marketplace value of security set by the buyers and sellers. Essentially, it is the price of financial security at which it can be bought or sold. Therefore, the market value is an actual value of a position in securities.

Uses in Interest Rate Swaps

Interest rate swaps are swaps in which the counterparties agree to exchange future interest payments. The interest payments are calculated on the predetermined notional principal value. The notional value can be denominated in any currency and can take any matter.

The payable interest rate payments are calculated periodically by multiplying the appropriate interest rates by the notional principal value. Strictly speaking, the notional principal value in interest rate swaps is a purely theoretical value employed only to calculate interest payments.

Uses in Currency Swaps

Currency swaps can be considered a type of interest rate swap. The counterparties exchange the principal and interest payments denominated in different currencies (e.g., US dollar vs. British pound). Similar to interest rate swaps, the calculation of interest rate payments for the currency swaps is also based on the predetermined notional principal values.

Note that currency swaps involve two notional values denominated in two different currencies. Unlike interest rate swaps, currency swaps also involve the exchange of abstract principalprincipleUses in Equity Options

Equity options (such as calls or puts) provide the right but not the obligation to buy or sell the underlying shares at the specified price at some point in the future. Commonly, each option is the chance to buy or sell 100 shares. The nominal value for equity options is the total value of a position in the options an investor holds.

In other words, the nominal value for an option can be determined by multiplying the number of underlying shares by the strike price of a claim. For example, if a call option provides its holder the right to obtain 100 underlying shares at $15 per share, the nominal value of this option is $1,500 ($15 x 100).