notional principal amount
value of loan the value used to represent a loan in calculating interest rate swaps
notional principal amount (for example, US$1 million). The notional amount is generally used only to calculate the size of cash flows to be exchanged. The floating rate is usually pegged to a reference rate such as the Libor, and the interest payments are settled net. When the swap is initiated
A swap is a derivative in which two parties agree to exchange a set of cash flows (or leg) for another set. A notional principal amount is used to calculate each cash flow; these are rarely exchanged by the parties. A swap is usually used to hedge a risk, such as an interest-rate risk
As with the floating rate payments, LIBOR forward rates are used to discount the notional principal for the three-year period. The PV of the notional principal is calculated by multiplying the days in the period and the floating rate forward discount factor.
Moreover, because the amount of the swap is notional, it is not necessary for the company to match the whole amount of the loan or to ensure that its entire life is covered. There may well be occasions when risk managers expect interest rate rises over the short to medium term. Continuing with a
Definitions of ’notional principal amount’ and meaning of ’notional principal amount’ are from the book publication, QFINANCE – The Ultimate Resource, © 2009 Bloomsbury Information Ltd. Find definitions for ’notional principal amount’ and other financial terms with our online QFINANCE Financial Dictionary.