Notional Value vs. Market Value: Understanding the Difference

Notional Value vs. Market Value: Understanding the Difference

Notional Value vs. Market Value: An Overview

The notional value and market value both describe the value of a security. Notional value speaks to how much total value a security theoretically controls—it is the sum of options, forwards, futures and foreign exchange currencies. Market value is the price of a security that can be bought or sold in the marketplace.

Notional Value

The notional value is the total amount of a security’s underlying asset at its spot price. The notional value distinguishes between the amount of money invested and the amount of money associated with the whole transaction. The notional value is calculated by multiplying the units in one contract by the spot price.

For example, assume an investor wants to buy one gold futures contract. The futures contract costs the buyer 100 troy ounces of gold. If gold futures are trading at $1,300, then one gold futures contract has a notional value of $130,000.

With interest rate swaps, the notional value is used to come up with the amount of interest due. With total return swaps, the notional value is used as part of several calculations that determine the swap rates. With equity options, the notional value refers to the value that the option controls. With foreign currency exchange and foreign currency derivatives, notional value is used to value the currencies.

Market Value

Market value is very different from notional value. Market value is the price of a security that buyers and sellers agree on in the marketplace. The security’s market value is calculated by determining the security’s supply and demand. Unlike the notional value, which determines the total value of a security based on its contract specification, the market value is the price of one unit of the security.

For example, assume that the S&P 500 Index futures are trading at $2,700. The market value of one unit of the S&P 500 Index is $2,700. Conversely, the notional value of one S&P Index futures contract is $675,000 ($2,700*250) because one S&P Index futures contract leverages 250 units of the index.

A company’s market value is a good indication of investors’ perceptions of its business prospects. The range of market values in the marketplace is enormous, ranging from less than $1 million for the smallest companies to hundreds of billions for the world’s biggest and most successful companies.

Market value can fluctuate a great deal over periods of time and is substantially influenced by the business cycle. Market values may plunge during the bear markets that accompany recessions, and often rise during the bull markets that are a feature of economic expansion.

Key Takeaways

  • Notional value is the total value of a position, how much value a position controls or the agreed upon amount in a futures contract.
  • Market value is the agreed upon price of a security, set by buyers and sellers in the marketplace.
  • Notional value accounts for the total value of the position, while market value is the price at which the position can be bought or sold, as set by the market.

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