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What is a Notional Amount?

Understanding the notional, or face value, amount will help correctly calculate payment amounts.
Knowing the notional is important for currency exchange.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 03 October 2014
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Also known as a notional value or a notional principal amount, a notional amount is the face value of a financial instrument. The amount is important, as it is necessary to accurately calculate any payments that must be made on that instrument. It is referred to as being notional because this amount does not actually change hands.

One of the easiest ways to understand how a notional amount is used in calculating payments is to consider the purchase of a bond issue. Assuming the bond is structured to pay interest to the holder at specific times throughout the life of the bond, it is important to know the face value. Without knowing this nominal amount, it is impossible to calculate the total of each interest payment as it comes due

Even in situations where the bond issue does not pay interest until the full maturity is reached, the notional value is still vital to the process. Because the interest payment will be based on the total amount of the principle or face value of the bond, the figure is necessary in order to determine how much interest the holder is entitled to receive. From this perspective, the amount is also important to the holder, as it makes it much easier to project the amount of return that can reasonably be expected on the investment.

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A notional amount is also important to calculating return on other types of investments, such as equity options, futures and forwards contracts, and shares of stock. In the case of stock, this value is usually referred to as a nominal amount because an investor may choose to engage in equity options as well as purchasing the shares outright. When this is the case, the nominal amount will focus on the number of shares involved in the equity call option rather than the number of shares actually purchased. This helps investors to leverage their earnings while still providing a principal figure to use in calculating return.

When entering into forwards or options as part of a currency exchange strategy, there are actually two notional amounts to consider. There is a nominal amount connected with each of the two currencies that are part of the exchange. Depending on exactly how the exchange strategy is implemented, one or the other amounts may serve as the basis for the trading activity. For example, if a domestic and a foreign currency are involved in the exchange, and the investor is choosing to hedge the exposure on the foreign currency, then the notional value of the foreign currency is fixed and serves as the basis for calculating earnings generated by the exchange.

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anon303127
Post 5

Or simply enough: the book value of the bond.

anon282876
Post 4

@anon276850: The Notional Value will be 100x the current price.

anon276850
Post 3

What is the notional value of a listed lookalike OTC Equity Option Transaction?

Say you buy 100 x XYZ OCT12 20 Strike for 25c?

anon155005
Post 2

The notional value does not equal the market value. The notional value is primarily used in calculating coupon payments from bonds or other financial instruments. E.g.., most bonds have a notional value of $1,000, but their market values vary depending on the riskiness of the bond.

anon127468
Post 1

I find terms like "notional" confusing. Could you please explain how notional relates to fair market value, i.e. if I sell an asset with a "notional value" of x, will the market value be equal to this notional value? Thanks.

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