Notional Principal Amount


DEFINITION of 'Notional Principal Amount'

In an interest rate swap, the predetermined dollar amounts on which the exchanged interest payments are based. Notional principal never changes hands in the transaction, which is why it is considered notional, or theoretical. Neither party pays or receives the notional principal amount at any time; only interest rate payments change hands.

BREAKING DOWN 'Notional Principal Amount'

For example, two companies might enter into an interest rate swap contract as follows:

-For three years, Company A pays Company B 5% interest per year on a notional principal amount of $10 million.

-For the same three years, Company B pays Company A the one-year LIBOR rate on the same notional principal amount of $10 million.

This would be considered a plain vanilla interest rate swap because one party pays interest at a fixed rate on the notional principal amount and the other party pays interest at a floating rate on the same notional principal amount.

  1. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  2. Interest Rate Swap

    An agreement between two parties (known as counterparties) where ...
  3. Floating Interest Rate

    An interest rate that is allowed to move up and down with the ...
  4. Liability Swap

    An exchange of debt related interest rates between two parties ...
  5. BOBL Futures Contract

    A futures contract with medium term debt that is issued by the ...
  6. Notional Value

    The total value of a leveraged position's assets. This term is ...
Related Articles
  1. Options & Futures

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  2. Charts & Patterns

    Introduction To Counterparty Risk

    Unlike a funded loan, the exposure from a credit derivative is complicated. Find out everything you need to know about counterparty risk.
  3. Active Trading

    An In-Depth Look At The Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  4. Forex Education

    Currency Swap Basics

    Find out what makes currency swaps unique and slightly more complicated than other types of swaps.
  5. Active Trading

    How Companies Use Derivatives To Hedge Risk

    Derivatives can reduce the risks associated with changes in foreign exchange rates, interest rates and commodity prices.
  6. Fundamental Analysis

    Using Decision Trees In Finance

    A decision tree provides a comprehensive framework to review the alternative scenarios and consequences a decision may lead to.
  7. Bonds & Fixed Income

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  8. Economics

    Currency Swap Basics

    A currency swap involves two parties exchanging a notional principal and interest to gain exposure to a desired currency.
  9. Economics

    5 Ways to Play the Stock Market after an Interest Rate Hike

    When the Fed will raises rates is still the unknown, but if it happens investors can benefit. Financials, consumer and growth stocks should do well.
  10. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  1. What does the notional principal of a derivative contract refer to?

    The notional principal amount of a derivative refers to the nominal, or predetermined, value used to calculate payments made ... Read Full Answer >>
  2. How can a company hedge with currency swaps?

    Currency swaps exist because there are disparate costs in the credit markets of two different countries. A company in a currency ... Read Full Answer >>
  3. What are the main risks associated with trading derivatives?

    The primary risks associated with trading derivatives are market, counterparty, liquidity and interconnection risks. Derivatives ... Read Full Answer >>
  4. Should you calculate Value at Risk (VaR) for counterparty credit risk?

    Value at risk (VaR) calculations may be helpful for risk management when trading credit default swaps and other derivatives ... Read Full Answer >>
  5. For what financial instruments is a modified duration relevant?

    The modified duration is a formula used to calculate the percent change in the price of a financial instrument when there ... Read Full Answer >>
  6. What is the difference between derivatives and swaps?

    Derivatives are securities with prices dependent on one or multiple underlying assets. Common derivatives include forward ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  2. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  3. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  4. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  5. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
  6. Indemnity

    Indemnity is compensation for damages or loss. Indemnity in the legal sense may also refer to an exemption from liability ...
Trading Center