Notional amount - Wikipedia

The notional amount on a financial instrument is the nominal or face amount that is used to calculate payments made on that instrument. Notionalamount FromWikipedia,thefreeencyclopedia Jumptonavigation Jumptosearch Financialinstrumentusedtocalculatevalue Thenotionalamount(ornotionalprincipalamountornotionalvalue)onafinancialinstrumentisthenominalorfaceamountthatisusedtocalculatepaymentsmadeonthatinstrument.Thisamountgenerallydoesnotchangeandisthusreferredtoasnotional.[1] Contents 1Explanation 2Examples 2.1Interestrateswaps 2.2Totalreturnswaps 2.3Equityoptions 2.4Foreigncurrency/exchange(FXderivatives) 2.5ETFs 3Notes 4Externallinks Explanation[edit] Contrastabondwithaninterestrateswap: Inabond,[2]thebuyerpaystheprincipalamountatissue(start),thenreceivescoupons(computedoffthisprincipal)overthelifeofthebond,thenreceivestheprincipalbackatmaturity(end). Inaswap,noprincipalchangeshandsatinception(start)orexpiry(end),andinthemeantime,interestpaymentsarecomputedbasedonanotionalamount,whichactsasifitweretheprincipalamountofabond,hencethetermnotionalprincipalamount,abbreviatedtonotional. Insimpleterms,thenotionalprincipalamountisessentiallyhowmuchofanassetorbondsapersonowns.Forexample,ifapremiumbondwereboughtfor£1,thenthenotionalprincipalamountwouldbethefacevalueamountofthepremiumbondthat£1wasabletopurchase.Hence,thenotionalprincipalamountisthequantityoftheassetsandbonds. Examples[edit] Interestrateswaps[edit] Inthecontextofaninterestrateswap,thenotionalprincipalamountisthespecifiedamountonwhichtheexchangedinterestpaymentsarebased;thiscouldbe8000USdollars,or2.7millionpoundssterling,oranyothercombinationofanumberandacurrency.Eachperiod'sratesaremultipliedbythenotionalprincipalamounttodeterminetheheightandcurrencyofeachcounter-party'spayment.Anotionalprincipalamountisanamountusedasareferencetocalculatetheamountofinterestdueonan'interestonlyclass'whichisnotentitledtoanyprincipal. Totalreturnswaps[edit] Inatypicaltotalreturnswap,onepartypaysafixedorfloatingratemultipliedbyanotionalprincipalamountplusthedepreciation,ifany,inanotionalamountofproperty,inexchangeforpaymentsbytheotherpartyoftheappreciation,ifany,onthesamenotionalamountofproperty.Forexample,assumetheunderlyingpropertyistheS&P500stockindex"AwouldpayBtheLondonInter-BankOfferedRate,multipliedbya$100notionalamountplusdepreciation,ifany,ona$100notionalinvestmentintheS&P500index.BwouldpayAtheappreciation,ifany,inthesamenotionalS&P500investment. Equityoptions[edit] Sharesalsohaveanotionalprincipalamount,butitiscallednominalinsteadofnotional. Forexample,ifstockoptioncontractsarebeingbought,thosecontractscouldpotentiallygivealotmoresharesthanwouldbepossibletocontrolbybuyingsharesoutright.Sothenotionalvalueisthevalueofwhatiscontrolled,ratherthanthevalueofwhatisowned. Forinstance,ifa100shareequitycalloptionispurchasedwithastrikeof$60forastockthatiscurrentlytradingat$60,thenithasthesameupsidepotentialasholding$6,000ofstock(1 option × 100multiplier × $60),butthesharesmayhavebeenpurchasedfor$5each(foratotalof$500).Bythismeasure,aleverageof$6,000/$500=12xhasbeenachieved.[3]Notethatifthestockpricemovesto$70,thedollarnotionalisnow$7,000(minusthecostofoptionandcommissiondifferential),butthequantity(unitnotional)isstill1contract. Foreigncurrency/exchange(FXderivatives)[edit] InFXderivatives,suchasforwardsoroptions,therearetwonotionals.Forexample,ifanindividualhasacalloptiononUSD/JPYcurrencystruckat110,andoneoftheseispurchased,thenthisgivesthebuyertheoptiontopay100USDandreceive110 × 100= 11,000JPY,sotheUSDnotionalis100USD,andtheJPYnotionalis11,000JPY. Notethattheratioofnotionalsisexactlythestrike,andthusifthestrikeismoved,oneofthenotionalswillchange.Forinstance,ifthestrikeismovedto100,andtheUSDfixedat100,theJPYnotionalbecomes10,000;thebuyerwillpaythesamenumberofUSDandreceivefewerJPY.Alternatively,JPYcurrencycouldbeheldconstantat11,000andchangetheUSDnotionalto110:hence,thebuyerwillpaymoreinUSDandreceivethesamenumberofJPY. Whenhedgingforeigncurrencyexposure,suchasforanAmericanbusinessinUSD,anoutflowof11,000JPY,theforeigncurrencynotionalmustbefixed. ETFs[edit] Mainarticle:Exchange-tradedfund Seealso:Inverseexchange-tradedfund Exchange-tradedfundstrackunderlyingpositions,soaninvestmentperformsequivalentlytopurchasingthatnumberofphysicalpositions,thoughthefundmayinfactnotdirectlypurchasethepositions,andinsteadusederivatives(especiallyfutures)toproducetheposition. LeveredETFs,notablyinverseexchange-tradedfunds,havetheunusualpropertythattheirnotionalchangeseveryday;theypaythecompoundeddailyreturn,soitisasifonewerere-investingeachday'searningsatthenewdailyprice.IfaninvestorhasaninverseETFinanassetthatgoesdown,theywillhavemoremoney,whichcanbeusedtoshortacheaperasset,henceone'sunitnotionalgoesup.Conversely,iftheassethasgoneupinvalueinthissituation,thenotionalwillgodown,asseenininverseexchange-tradedfunds, Notes[edit] ^Notionalamount–DefinitionfromInvestorDictionary–DefinemeaningofthewordNotionalamount ^Soldatpar. ^AdifferentmeasureofleveragewouldbeDelta. Externallinks[edit] ChicagoMercantileExchange:Glossary Retrievedfrom"https://en.wikipedia.org/w/index.php?title=Notional_amount&oldid=1067774432" Categories:Derivatives(finance)InterestratesSwaps(finance)Hiddencategories:ArticleswithshortdescriptionShortdescriptionmatchesWikidata Navigationmenu Personaltools NotloggedinTalkContributionsCreateaccountLogin Namespaces ArticleTalk English expanded collapsed Views ReadEditViewhistory More expanded collapsed Search Navigation MainpageContentsCurrenteventsRandomarticleAboutWikipediaContactusDonate Contribute HelpLearntoeditCommunityportalRecentchangesUploadfile Tools WhatlinkshereRelatedchangesUploadfileSpecialpagesPermanentlinkPageinformationCitethispageWikidataitem Print/export DownloadasPDFPrintableversion Languages FrançaisLietuvių Editlinks