# Swaps and Notional Amount doubt

"Since the notional amount must be repaid at maturity, the fixed rate on the swap is very close to the interest rate in the final year of the swap. It is the size of the final cash flow relative to the other cash flows that weigh the fixed rate much more heavily toward the final year rate."

I don’t understand why this statement is inaccurate. The rationale behind the inaccuracy is that no notional amount is exchanged at initiation so no notional amount will be exchanged at contract expiration.

How is this possible? In order to find the value of the swap we multiply the Notional by (SFR * sum of discount factors + last year discount factor). So we do pay notional at maturity?

Assuming that this is a plain vanilla interest rate swap (as opposed to a currency swap), no.

Remember, payments are netted. If notionals were exchanged at inception and maturity, you would pay the counterparty the notional and they would pay you the (same) notional, so the net is zero.

But I still don’t understand why would we multiply NP to (SFR * sum of discount factors + last year discount factor). I understand the first part of the equation helps us get interest payments, but if notionals are not exchanged at maturity, why multiply last year (e.g. Df of year 4) discount factor by the Notional principal? What am I missing here?

In a plain vanilla interest rate swap, you’re exchanging cash flows: one fixed, one varying with current interest rates.

You can exchange cash flows in the tens of dollars, or hundreds of dollars, or thousands of dollars, or millions of dollars. You need an objective method to determine the magnitude of the cash flows exchanged.

Enter the notional principal. It’s nothing more nor less than an objective means of determining the magnitude of the cash flows.

You want cash flows in the tens of dollars? Multiply the interest rates by \$1,000.

You want cash flows in the hundreds of dollars? Multiply the interest rates by \$10,000.

You want cash flows in the thousands of dollars? Multiply the interest rates by \$100,000.

You want cash flows in the millions of dollars? Multiply the interest rates by \$100,000,000.

In practice, that’s all the notional principal is: a method for scaling the magnitude of the cash flows. It’s not exchanged; it’s simply a multiplier for the interest rates.

Understood. This clears a lot of stuff. Thank you!!

My pleasure.