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 oneyear 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.

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How does an entrepreneur choose a business structure?
Swaps are derivative contracts between two parties that involve the exchange of cash flows. Interest rate swaps involve exchanging ... Read Full Answer >> 
When was the first swap agreement and why were swaps created?
Swap agreements originated from agreements created in Great Britain in the 1970s to circumvent foreign exchange controls ... Read Full Answer >> 
What are some common markets where notional value is used?
Notional value is commonly used in futures and swap markets. The notional value is the total net amount of derivative contracts, ... Read Full Answer >> 
How are swap agreements financed?
Since swap agreements involve the exchange of future cash flows and are initially set at zero, there is no real financing ... Read Full Answer >> 
What are the risks involved with swaps?
The main risks associated with interest rate swaps, which are the most common type of swap, are interest rate risk and counterparty ... Read Full Answer >> 
What are interest rate swaps on the OTC market?
Interest rate swaps are agreements where counter parties agree to exchange interest rate cash flows based upon the difference ... Read Full Answer >>

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