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]Contrast a bond with an interest rate swap
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.
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.
