Notional Value
What is Notional Value?
Notional values are most discussed in derivatives and currency transactions because those transactions often involve hedging, which means that a small amount of money can influence a very large investment. The term helps distinguish between the amount of money actually invested from the amount of money involved in the whole transaction.
How Does Notional Value Work?
Consider an interest rate swap, which is a contractual agreement between two parties to exchange interest payments. Let's assume Charlie owns a $1 million investment that pays him LIBOR + 1% every month. As LIBOR goes up and down, the payment Charlie receives changes. Now assume that Sandy owns a $1 million investment that pays her 1.5% every month. The payment she receives never changes.
Charlie decides that that he would rather lock in a constant payment and Sandy decides that she'd rather take a chance on receiving higher payments. So Charlie and Sandy agree to enter into an interest rate swap contract.
Under the terms of their contract, Charlie agrees to pay Sandy LIBOR + 1% per month on a $1 million principal amount. This is the notional value. Sandy agrees to pay Charlie 1.5% per month on the $1 million notional amount.
Why Does Notional Value Matter?
Notional value is the total asset value of a hedged position.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.