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Notional principal contract

The term notional principal contract (NPC) is a term of art used by U.S. federal income tax professionals for contracts based on an underlying notional amount. The reason the underlying amount is "notional" is that neither party to the NPC is required to actually hold the property comprising the underlying amount. NPCs involve two parties who agree contractually to pay each other amounts at specified times, based on the underlying notional amount. The simplest example of an NPC is a so-called interest rate swap, in which one party pays the other party an amount each quarter determined by multiplying a floating, market-determined interest rate by the notional amount; and Party B pays Party A on the same date an amount determined by multiplying a fixed interest rate by the notional amount.