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.

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At the end of the three years, the two firms swap their notional principals.

The two firms have set the exchange rate at the current spot rate of 0.60USD/1CD for the initial swap of the notional principals and for the swap back in three years.

The only certain gain was a known currency exchange rate for the initial and final swap of the notional principals. Whether or not this was a financial gain over what could have been attained in the foreign currency markets is unknowable.

Chapter 7 Swaps

On each of the payment dates, t, the contract calls for the fixed-rate payer to pay the notional principal multiplied by a fixed proportion (1 + [pi]) H(t) to the floating-rate payer and to receive in return the notional principal multiplied by S(t).

The second enters into a portfolio of k annual survivor forward contracts, each of which requires payment of the notional principal multiplied by (1 + [[pi].sub.n]) H(n) and the receipt of the notional principal multiplied by S(n), n = 1,2,...

First, consider two parties wishing to exchange the notional principal (7) multiplied by the actual survivorship of cohorts j and k.

from which it follows that the fair value in a floating-for-floating basis swap requires one party to make payments determined by the notional principal multiplied by [S.sub.j](n) and the other party to make payments determined by the notional principal multiplied by [kappa][S.sub.k](n); [kappa] is determined at the outset of the basis swap and remains fixed for the duration of the contract.

Thus, in the case of a floating-for-floating cross-currency basis swap, on each payment date, n, one party will make a payment of the notional principal multiplied by [S.sub.j](n) and receive in return a payment of [[kappa].sub.FX] [S.sub.k](n).

Thus, if the notional principal were $1 million and the time frame were 1 year, a long position in a December futures contract at a price of [pi] = 3 percent would notionally commit the holder to pay $1.03 million multiplied by the expected size of the cohort surviving and to receive $1 million multiplied by the actual size.