Loading the player...

What is 'Notional Value'

Notional value is the total value of a leveraged position's assets. This term is commonly used in the options, futures and currency markets because of leverage, wherein a small amount of invested money can control a large position in the markets.

For example, one S&P 500 index futures contract obligates the buyer to 250 units of the S&P 500 index. If the index is trading at $1,000, then the single futures contract is similar to investing $250,000 (250 x $1,000). Therefore, $250,000 is the notional value underlying the futures contract.

BREAKING DOWN 'Notional Value'

The notional value is essentially how much of a particular asset an investor has. It is often mixed with market value but there is a clear distinction: The notional value and market value both describe the amount of a security. The notional value accounts for the total number of forwards, options, foreign exchange currencies and futures, while the market value is the price of a security that can be bought or sold in the market.

Notional value may be seen and used in five ways: through interest rate swaps, total return swaps, equity options, foreign currency exchange derivatives and exchange-traded funds (ETFs).

Interest Rate Swaps

In interest rate swaps, the notional value is the specified value on which exchanged interest payments are based on. The notional value in interest rate swaps is used to come up with the amount of interest due for an interest-only class.

Total Return Swaps

Total return swaps involve a party that pays a floating or fixed rate multiplied by a notional value amount plus the decrease in notional value amount of property. This is swapped for payments by another party that pays the appreciation of notional value amount of the involved property.

Equity Options

Shares of stock also involve notional values. Instead of the term "notional," it is coined as "nominal."

For example, buying stock option contracts would potentially give an investor more shares than he could control by purchasing shares directly. The notional value is the value of the investor can control rather than the value of he can control.

Foreign Currency Exchange and Foreign Currency Derivatives

Foreign exchange derivatives like forwards and options have two notional values. Since these involve trading two currencies, they both receive separate notional values. Hedging foreign currency also involves having a fixed foreign currency notional value.

Exchange-Traded Funds

For investments to perform like another well-performing fund, exchange-traded funds track and follow other positions. Some ETFs do not directly buy the positions. Instead, they use derivatives such futures to create the position.

Inverse exchange-traded funds have the unique characteristic of having a different notional value daily. The reason behind this is the daily compounded return is paid making it reinvest its daily earnings.

RELATED TERMS
  1. Notional Principal Amount

    In an interest rate swap, the predetermined dollar amounts on ...
  2. Amortizing Swap

    An exchange of cash flows, one of which pays a fixed rate of ...
  3. Airbag Swap

    An interest rate swap whose notional value adjusts according ...
  4. Fixed Price

    The leg of a swap that is based on an unchanging interest rate. ...
  5. Floating Price

    The leg of a swap that is based on a fluctuating interest rate. ...
  6. Swap

    A derivative contract through which two parties exchange financial ...
Related Articles
  1. Trading

    Understanding Notional Value

    This term is commonly used in the options, futures and currency markets because a very small amount of invested money can control a large position.
  2. Trading

    Interest Rate Swaps Explained

    Plain interest rate swaps that enable the parties involved to exchange fixed and floating cash flows.
  3. Managing Wealth

    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. Trading

    Currency Swap Basics

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

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  6. Trading

    Hedging With Currency Swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it.
  7. Investing

    Currency Swap Basics

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

    How Are Interest Rate Swaps Valued?

    When trading in financial markets, higher returns are generally associated with higher risk. Hedge your risk with interest rate swaps.
  9. Trading

    Different Types of Swaps

    Investopedia explores the most common types of swap contracts.
  10. Trading

    Derivatives 101

    Learn how to use this type of investment as an alternative way to participate in the market.
RELATED FAQS
  1. What is the difference between notional value and market value?

    Learn more about the notional and market value, how to calculate the notional value of a futures contract and the difference ... Read Answer >>
  2. What are some common markets where notional value is used?

    Find out more about the notional value of securities and which markets commonly use the notional value to indicate the total ... Read Answer >>
  3. How is the spot price related to a derivative's notional value?

    Learn about the relationship between the spot price and notional value of derivative securities and how to calculate the ... Read Answer >>
  4. What does the notional principal of a derivative contract refer to?

    Find out more about the notional principal amount, interest rate swap agreements and how the notional principal amount in ... Read Answer >>
  5. How can I calculate the delta adjusted notional value?

    Find out how to calculate the delta adjusted notional value of an options contract, and why gross notional value cannot be ... Read Answer >>
  6. How does an entrepreneur choose a business structure?

    Learn more about interest rate swaps and currency swaps, how these swaps are used and the difference between interest rate ... Read Answer >>
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center