Notional value

Written by Fmi.Online Friday December 9, 2022
Notional value refers to the total net amount of a derivative transaction, usually an interest rate swap, a forward contract, a cross currency swap or an options contract.

Explanation :

  Notional value is different from the amount of money invested in a derivative contract. In fact, the notional amount is a reference value for calculating the interest on the transaction, and it expresses how much of the total value the derivative theoretically controls.For instance, in an options contract of 100 shares of an underlying asset, the notional amount is the contract size (100) times the price of the underlying asset. So, if the option is purchased at $3 per share and the price of the underlying security is $24, the notional amount is $3 x 100 x $24 = $7,200.

In a nutshell :

  • Notional value is a term often used to value the underlying asset in a derivatives trade.
  • Notional value of derivatives contracts is much higher than the market value due to a concept called leverage.
  • Notional value is integral in assessing portfolio risk, which can be very useful when determining hedge ratios to offset that risk.
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