Difference between notional and market value

ASPECT

NOTIONAL VALUE

MARKET VALUE

Definition

Notional value refers to the theoretical, or underlying, value of an asset in a contract – for example, derivatives. It does not reflect real market price; instead, it expresses the size of exposure in the contract.

It is defined as the price at which an asset can be currently obtained from a financial market, that is, the price at which it can be bought or sold at any given time.

Application

Notional value establishes what is the scale of investment in financial instruments like derivatives, which enables investors and institutions to calculate the leverage and exposure involved with respect to a contract without actually having to invest the full amount upfront.

The market value gives the investors an opportunity to measure the true price of the asset at the real-time moment and allow making proper decisions on transaction.

The value is constantly fluctuating with change in demand and supply.

Calculation

Calculated on the basis of the contract terms, for instance: in a futures contract, the notional value would be a product of units and price agreed.

It is calculated while observing the market prices of the current market moments, based on supply and demand, sentiment, and other factors in the market. For instance, the stock price on the stock exchange at any given moment.

Uses

Notional value is the most critical form when it comes to the assessment of leverage and the management of risk, especially in relation to derivatives as it permits one to be able to determine the possible risks or fees incurred without having the actual money that had been exchanged.

Market value is important in making real-time investment decisions and determining the worth of the portfolios. It shows the true cost or selling price of the assets. The decision of whether to buy or sell is arrived at based on the use of market value.

Instruments

Most associated with derivatives like options, futures, and swaps; contracts are based on the notional value rather than actual upfront capital invested.

Most associated with derivatives like options, futures, and swaps; contracts are based on the notional value rather than actual upfront capital invested.

Influence

The notional value is stable and reflects the actual size of the transaction and generally is not influenced by short-term price fluctuations or market sentiments. It depends solely on contract terms, thus when contract terms are updated, it varies.

Market value is extremely volatile, meaning that it varies due to external factors such as market demand and supply, investor sentiment, economic conditions, and company performance.

Importance

This is especially going to be of benefit to the risk managers, traders, and financial institutions in sizing the exposure and leverage without necessarily having to pull out the full capital upfront. Notional value is quite handy for derivative exposure management.

This is important to investors and analysts because it gives one real-time values of assets. It also helps one evaluate the worth of the company and is therefore integral in formulating strategies for asset allocation, buying, and selling.

Fluctuations

It is generally stable for the whole duration of the contract unless adjustments are made. It represents intended exposure rather than movement in the market.

Changes occur frequently with movements in the market, reflecting actual worth of the asset. Fluctuations occur in any change in market conditions and investor perceptions.

Relevance

Very relevant in measuring exposure of derivatives and helps to derive the value of the derivative, as it describes how much value a derivative represents relative to the market. It thus explains the effect of leverage.

It is important for real time buy/sell decisions, as the value itself indicates what the asset is actually worth at the given moment and directly affects profitability.

Impact on Investors

It helps the investor and the manager assess gains or losses based on the scale of exposure in terms of the notional amount with no financial investment for the full amount.

It calculates the actual cost or return on an asset when it is purchased or sold. Market value impacts investors as this is the expression of any profit or loss potential at real time by market movements.

Significance

It indicates overall exposure or obligation in a contract and helps in understanding what leverage is being used. For example, high leverage may be indicated by a large notional value in a smaller position size.

It reflects the present tradability and perceived value of a security. Market value shows what buyers and sellers are willing to pay at any moment and hence is important for trade decisions and liquidity.

Example

If one buys 100 shares of a stock at ₹1,500 each, the notional value comes out to be ₹1,50,000 (100 shares * ₹1,500). This helps in analyzing the notional exposure without making an actual cash transaction at the notional value

If the market value of a share is 445 Rs per share then it shows that investors needs to pay this much to buy that particular share at that time, and the price fluctuates with changing market forces.