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What is a Notional Amount?

Malcolm Tatum
By
Updated May 16, 2024
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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.

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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Malcolm Tatum
By Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing to become a full-time freelance writer. He has contributed articles to a variety of print and online publications, including SmartCapitalMind, and his work has also been featured in poetry collections, devotional anthologies, and newspapers. When not writing, Malcolm enjoys collecting vinyl records, following minor league baseball, and cycling.
Discussion Comments
By anon303127 — On Nov 13, 2012

Or simply enough: the book value of the bond.

By anon282876 — On Aug 01, 2012

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

By anon276850 — On Jun 27, 2012

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

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

By anon155005 — On Feb 22, 2011

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.

By anon127468 — On Nov 16, 2010

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.

Malcolm Tatum
Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing...
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