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What is the notional value of a forward currency contract?



Currencies Unplugged
Merk Mutual Funds sheds light on key concepts relating to the currency market.

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The notional value of a forward currency contract is the underlying amount that an investor has contracted to buy and sell (currencies always trade in pairs – by implication, when an investor contracts to buy one currency, they also contract to sell another currency). For example, an investor might enter into a contract to purchase 1 million Australian dollars (AUD) with U.S. dollars (USD) in one month’s time, at an exchange rate of 0.9000. The notional value for this contract in USD terms is therefore $900,000.

Importantly, though the notional value may be a large sum, there is often no initial outlay required to enter into such a contract. As such, an investor is free to deploy funds into various investments until the value date of the contract.

If an investor has an amount invested in assets such as cash, bonds or stocks that is equivalent to, or exceeds, the total net notional value of all forward currency contracts outstanding, that investor is deemed to have fully collateralized the notional value of their forward currency contracts with said investments.

Both the Merk Absolute Return Currency Fund and the Merk Asian Currency Fund have historically utilized forward currency contracts to gain currency exposure. The notional value of these contracts is typically fully collateralized with U.S. T-Bills or other money market instruments.

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