Notional amount
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The notional amount (or notional principal amount or notional value) on a financial instrument is the nominal or face amount that is used to calculate payments made on that instrument. This amount generally does not change hands and is thus referred to as notional.[1]
In the context of an interest rate swap, the notional principal amount is the specified amount on which the exchanged interest payments are based; this may be in US dollars, or pounds sterling, or whatever currency the swap is based on. Each period's rates are multiplied by the notional principal amount to determine the value of each counter-party's payment. A notional principal amount is the amount used as a reference to calculate the amount of interest due on an 'interest only class' which is not entitled to any principal.
In a typical total return swap, one party pays a fixed or floating rate multiplied by a notional principal amount plus the depreciation, if any, in a notional amount of property in exchange for payments by the other party of the appreciation, if any, on the same notional amount of property. For example, assume the underlying property is the S&P 500 stock index. A would pay B LIBOR times a $100 notional amount plus depreciation, if any, on a $100 notional investment in the S&P 500 index. B would pay A the appreciation, if any, in the same notional S&P 500 investment.
In simple terms the notional principal amount is essentially how much of the asset or bonds a person has. For example, if I bought a premium bond for £1 then the notional principal amount would be £1. Hence the Notional principal amount is the quantity of the assets and bonds.
Shares also have a notional principal amount but it is called nominal instead of notional.
If you are buying stock option contracts, for example, those contracts will give you control of a lot more shares than you could control by buying shares outright. So the Notional Value is the value of what you control rather than the value of what you own.
