Explanation
Contrast a bond with an interest rate swap:
- In a bond, the buyer pays the principal amount at issue (start), then receives coupons (computed off this principal) over the life of the bond, then receives the principal back at maturity (end).
- In a swap, no principal changes hands at inception (start) or expiry (end), and in the meantime, interest payments are computed based on a notional amount, which acts as if it were the principal amount of a bond, hence the term notional principal amount, abbreviated to notional.
In simple terms the notional principal amount is essentially how much of the asset or bonds a person has. For example, if a premium bond was bought for £1 then the notional principal amount would be £1. Hence the notional principal amount is the quantity of the assets and bonds.
Read more about this topic: Notional Amount
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