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Notional value vs. market value

The notional value represents an instrument’s theoretical value based on its T&C, while the market value reflects the actual price at which it can be traded.

Understanding the difference between notional value and market value is a critical concept for retail investors to grasp. These two values represent distinct aspects of financial instruments and can significantly impact investment decisions and portfolio performance.

Whether you’re a seasoned investor or new to the world of finance, this article will help you explore the difference between these important terms.

What is notional value?

Notional value is an important idea in finance. It is the set value used for calculations in financial deals. This value does not change, even if the actual market price changes.

For example, let’s say there is an interest rate swap deal with a notional value of 10 crore rupees. This means that 10 crore rupees is the amount used to work out the interest payments between the two parties. However, 10 crore rupees itself is not paid or exchanged. It is just the fixed number used for calculations.

Notional value and market price are not the same thing. Market price goes up and down based on supply, demand and other factors. But notional value stays the same throughout the deal, as agreed by both sides from the start. Notional value only matters for doing the math in the deal.

What is the market value?

Market value is the actual price that a financial product can be bought or sold for in the market at any given time. This value goes up and down based on various factors.

For example, let’s say a company issued bonds worth 50 lakh rupees last year. The market value of those bonds today may be different from 50 lakh rupees. It could be higher if the company is doing well and more investors want to buy the bonds. Or it could be lower if the company is struggling and investors want to sell the bonds.

The market value changes based on things like supply and demand, the company’s performance, economic conditions, and investor sentiment. Unlike the fixed notional value used for calculations, the market value fluctuates constantly as traders buy and sell the bonds on the market.

The differences at a glance

FeatureNotional ValueMarket Value
DefinitionTotal value of a position in a financial instrumentCurrent price of a security in the Indian stock market
FocusUnderlying value of the contractPrice determined by supply and demand on Indian stock exchanges
RelevancyMostly for derivatives (options, futures, swaps)Applies to all types of financial securities (stocks, bonds, derivatives) traded on Indian exchanges
Example (Stock)You buy 100 shares of Reliance Industries (RIL) at ₹1,500 per share. Notional value = ₹1,500 x 100 = ₹1,50,000The current market price of RIL is ₹1,600 per share.
Example (Derivative)A futures contract on Nifty 50 with a notional value of ₹5 croreThe market value of the contract fluctuates based on the Nifty 50 index. Today, it might be ₹20,000.
SignificanceIndicates the overall exposure or obligation of a contractReflects the current tradability and value perception of the security on Indian exchanges
Impact on InvestorHelps understand potential gains or losses based on contract size (in INR)Determines the actual cost of acquiring or selling the security on Indian exchanges (in INR)

Frequently Asked Questions

Is notional value the same as face value?

Yes, notional value is often considered the same as face value or par value, representing the predetermined theoretical value of a financial instrument.

Can notional value change over time?

No, notional value remains constant throughout the life of a contract or financial instrument, as it is predetermined by the agreed-upon terms and conditions.

How does market value impact my investment returns?

Market value directly affects your investment returns, as it represents the actual price at which you can buy or sell the instrument in the market. Higher market value means potential for higher returns when selling.

Should I focus more on notional value or market value when investing?

While notional value is important for understanding your exposure and contractual obligations, it is crucial to pay close attention to market value when making investment decisions, as it reflects the true worth of your holdings in the current market conditions.

Is notional value only relevant for derivative instruments?

No, the concept of notional value is applicable to various financial instruments, including bonds, loans, and other contracts where a predetermined value is used as a reference for calculations or payments.

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