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—for instance through derivatives contracts or debt obligations. A practical application might include interest rate swaps.
Market value, on the other hand, is the price of a security right now that can be bought or sold on an exchange or through a broker. Market value is also used to refer to the market capitalization of a publicly traded company and is determined by multiplying the number of outstanding shares by the current share price.
Key Takeaways
- Notional value represents the total value controlled by a financial position or contract, like a derivatives contract or debt obligation.
- Market value is the current price at which a security can be bought or sold based on supply and demand.
- The notional value is calculated by multiplying the units in a contract by the spot price of the underlying asset.
- Examples of notional value use include interest rate swaps, total return swaps, equity options, and currency derivatives.
- Market value fluctuates due to market conditions and business cycles, impacting investors’ perceptions and decisions.
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Understanding Notional Value in Financial Markets
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.
Notional value can be used in futures and stocks. However, it is more often seen and used in the following five ways: through interest rate swaps, total return swaps, equity options, foreign currency exchange and foreign currency derivatives, and exchange-traded funds (ETFs).
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.
Important
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.
Exploring Market Value and Its Impact on Investments
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.
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 trillons 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.
Real-World Examples: Notional vs. Market Value
The market value of a security or financial contract is the amount you can buy it for in the marketplace. 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 is the underlying value of that derivative contract in relation to its market value. Say that one futures contract of the S&P consists of 250 units. Then, 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.
What Is an Example of Notional Value?
For example, assume that a wheat futures contract was selling for $50. Each wheat futures contract consists of 5,000 bushels of wheat. The notional value would be $50 x 5,000 = $250,000
What Is a Company’s Market Value?
A company’s market value, also known as its market capitalization, is how much a company is worth financially. It is calculated by multiplying a company’s current share price by its shares outstanding. For example, say Company ABC’s share price was $10 and it had 20,000 shares outstanding, its market cap would be $200,000.
What Is the Difference Between Book Value and Market Value?
Book value and market value are two ways of estimating the value of a company. Book value looks at a company’s financial statements and values a company as its total assets minus intangible assets and liabilities. Market value, on the other hand, looks at a company’s value based on its share price. It multiplies a company’s share price by its total shares outstanding.
The Bottom Line
The notional value is the total value represented by a contract or obligation, whereas market value fluctuates based on supply, demand, and market conditions.
The market value will vary due to supply and demand and prevailing market conditions. If the options contract is very far out of the money, its market value may be close to zero, or if interest rates rise substantially, the market value of the bond will be less than $1,000.
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