The value that represents the face value of the financial instrument basis on which the payments are calculated is named as Notional amount.

Simply, it is the assumed principal amount of a financial contract on which the exchanged interest rates are based.

For example, A and B entered into an agreement to exchange interest payments with each other. A holds an investment that is valued at Rs. 1 lacs and earns interest on a floating rate benchmark plus 1% every month. Since the floating rate changes periodically the interest payment received is not constant and fluctuates as per the market rates.

On the other hand, B investment is valued at Rs. 1 lac paying a fixed interest payment of 2%.

Since being a fixed rate interest payment it remains constant throughout the year.

A and B entered into an exchange of interest payment agreement wherein A will receive a fixed interest payment and B will receive a floating interest rate payment.

Since the interest is calculated on the principal amount of Rs. 1 lacs it is called Notional Principal amount.

If the floating rate of interest drops to 0.5% in a particular month then B will receive Rs. 15000 i.e. (1,00,000 * 0.5%+1%) and correspondingly A will receive Rs.20,000 interest i.e. ( Rs. 1,00,000 * 2%).

Therefore, under the interest rate exchange agreement, A will pay B Rs. 15,000 whereas B will pay A Rs.20,000.

Under the transaction, B owes A Rs.5000 in interest payments.

How Notional value is different from Market Value

Notional value describes the value of an asset as a whole whereas the market value refers to the price at which the security can be bought and sold.

The total value of assets could include options, foreign exchange currencies, stocks, options contracts, etc.

The market value is the straightforward price of assets determined within the market.

Simply the notional value tells you what an investor invests in combination with the value of the security an investor is investing into.

Notional Value = Investment amount * market value of the asset.

Market value simply depends on the supply and demand in the market for that particular security.

Notional value under the stock contract is the value controlled by investors rather than what is owned by the investor.

Under the currency swap, the notional value is used to calculate the value on which interest payments will be exchanged