NDF
19 hours agoA non-deliverable forward (NDF) is a type of forward or futures contract where the two parties settle the difference between the agreed NDF price and the current spot market price at the conclusion of the contract.
An NDF is a currency derivatives contract between two parties that involves exchanging cash flows based on the NDF and the current spot rates. One party compensates the other for the difference resulting from this exchange.
Cash flow = (NDF rate – Spot rate) * Notional amount
The largest markets for NDFs include the Chinese yuan, Indian rupee, South Korean won, Taiwan dollar, and Brazilian real. Other notable markets consist of the Chilean peso, Colombian peso, Indonesian rupiah, Malaysian ringgit, Philippine peso, and New Taiwan dollar.
What is an NDF?
NDFs are traded over the counter (OTC) and operate similarly to forward contracts for currencies that cannot be converted. They enable traders to hedge against exposure in markets where direct trading in the underlying physical currency is not possible.
Instead of delivering the actual currency pair, the contract is settled through a net payment in a convertible currency, based on the difference between the agreed forward exchange rate and the actual spot fixing that occurs later.
This fixing is a standard market rate established on the fixing date, which is typically two days before the forward value date for most currencies. The basis for the fixing can differ by currency, being either an official exchange rate set by the central bank or an average of interbank prices at a designated time.
NDFs differ from deliverable forwards in that they operate outside the direct jurisdiction of the authorities governing the respective currencies, and their pricing is not necessarily influenced by domestic interest rates.
The majority of NDF transactions are settled in U.S. dollars, although trading against other convertible currencies like euros, sterling, and yen is also possible.
How does an NDF work?
All NDF contracts specify the currency pair, notional amount, fixing date, settlement date, and NDF rate, and require that the prevailing spot rate on the fixing date be used to finalize the transaction.
The fixing date is when the difference between the current spot market rate and the agreed rate is calculated. The settlement date is when the payment of this difference is due to the receiving party.
For example, if one party agrees to buy Chinese yuan (selling dollars) and the other agrees to buy U.S. dollars (selling yuan), a non-deliverable forward can be established between them.
They might agree on a rate of 7.00 for $1 million U.S. dollars, with the fixing date set for one month later and settlement due shortly after.
If, after one month, the rate is 6.9, it indicates that the yuan has appreciated against the U.S. dollar, and the party that purchased yuan is owed money.
Conversely, if the rate rises to 7.1, it shows that the yuan has depreciated (the U.S. dollar has strengthened), meaning the party that bought U.S. dollars is owed money.
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