Notional principal amount

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Notional principal amount

In an interest rate swap, the predetermined dollar principal on which the exchanged interest payments are based.

Notional Principal Amount

In an interest rate swap, the arbitrary amount over which interest is calculated. Suppose the two legs of the swap are a fixed interest rate, say 3.5%, and a floating interest rate, say LIBOR + 0.5%, and the notional principal amount is $1 million. In such a swap, the only things traded are the two interest rates, which are calculated over the notional principal amount. That is, the $1 million is never exchanged, but the interest is calculated with reference to it. For example, the fixed interest is 3.5% of $1 million (or $35,000). It is also called the notional value.
References in periodicals archive ?
The amount payable by the counterparty to L also is payable at a specific interval (18 months after initiation of the swap or its earlier termination or assignment) and is calculated by reference to two separate specified indices (LIBOR and a published aviation fuel price index) upon combined notional principal amounts equal to $500 million.
Notional principal contracts typically employ swaps or other reciprocal arrangements that provide for payments at specified intervals by a party to a counterparty calculated by reference to a specified index applied to a notional principal amount, for which the counterparty promises to pay similar amounts.
A notional principal contract is defined as "a financial instrument that provides for the payment of amounts by one party to another at specified intervals calculated by reference to a specified index upon a notional principal amount in exchange for specified consideration or a promise to pay similar amounts.
Higher notional principal values are suggestive of greater involvement in derivatives, while smaller notional principal amounts generally indicate relatively lighter derivatives activity.
The interpretation of notional principal amounts for end-user interest rate derivatives, however, has to be made carefully and should consider the potential limitations of notional principal information.
Thus, notional principal disclosures can vary from the disclosure of a single notional principal amount for a firm's portfolio of interest rate derivatives to the disclosure of detailed notional principal amounts for each type of interest rate derivative or each specific instrument.
As such, notional principal amounts appear to provide reasonably relevant information about end-user interest rate derivatives activity.
Notional principal amounts often are used to express the volume of these transactions but do not represent the much smaller amounts potentially subject to credit risk.