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. 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.
- Notional value is the total value controlled by a position or obligation; e.g. how much value is represented by a derivatives contract.
- Market value is price of a security set by buyers and sellers in the marketplace through supply and demand.
- For example, a call option representing 100 shares of XYZ stock with a strike price of $40 may trade in the market for $1.20 per contract (100 x $1.20 = $120 market value), but represents a notional value of $4,000 (100 x $40).
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. But 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.
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.
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.
The Bottom Line
Market value and notional value each represent different sums that are important for investors to understand. The notional value is how much value is represented by an obligation or contract—for instance, an options contract that controls 1,000 bushels of wheat or a corporate bond with a face value at maturity of $1,000. The market value of these obligations, however, will vary due to supply and demand and prevailing market conditions. For instance 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 for less than $1,000.