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.
Investopedia explains '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.