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The amount or other reference amount used to specify a contract’s size and calculate its payments; it is distinct from the contract’s market value.
Save conceptNotional value describes the amount or other reference amount on which a contract is based. It is a measure of contract size. In a exchange contract, it can be the amount of to be exchanged. In other it may simply be the amount used in a payment calculation. Its precise economic role therefore depends on the type of contract.
The contract applies its price, rate or payment formula to that amount. A agreement to buy US$100,000 has a US-dollar notional amount of US$100,000, even though its current market value depends on how the agreed exchange terms compare with current prices. Regulators can use outstanding notionals when applying size limits, but calculating a threshold and measuring a potential loss are different tasks.
Imagine a hypothetical company agrees to buy US$100,000 at 90 rupees per dollar on a future date. The dollar notional is US$100,000 and the specified rupee payment is 9 million rupees. If a reporting rule requires the dollar notional to be converted at an assumed 95 rupees per dollar, that equivalent is 9.5 million rupees. This reporting conversion does not change the contract’s agreed purchase price.
Distinguish notional amount from the cost of replacing the contract, the cash paid when it is arranged and the loss if a party defaults. A large notional can support a small net payment in one contract and an actual exchange of substantial funds in another. A statement about risk also needs the payment rules and other relevant protections; notional size alone is insufficient.
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