A non-deliverable forward (NDF) refers to a forward contract signed between two signatories for exchanging cash flows based on the existing spot rates at a future settlement date. It allows businesses to settle their transactions in a currency other than the underlying freely traded currency being hedged. A non-deliverable forward is a foreign exchange derivatives contract whereby two parties agree to exchange cash at a given spot rate on a future date. The contract is ndf meaning settled in a widely traded currency, such as the US dollar, rather than the original currency. NDFs are primarily used for hedging or speculating in currencies with trade restrictions, such as China’s yuan or India’s rupee.

what is the difference between an NDF and a FX Forward contract

In a NDF, the https://www.xcritical.com/ contract will besettled in the base currency at the fx fixing rate of that currencyon the settlement or value date. These contracts tend to trade ifthere is some friction in the trading of, settlement of, or deliveryof the underlying currency. These frictions could be in the form ofcurrency controls, taxes, fees etc. If a business has hedged against currency risk that it is exposed to with an option trade it can also benefit if exchange rates change favourably. This is the exchange rate on which the settlement calculation will be based. In our example, this could be the forward rate on a date in the future when the company will receive payment.

Understanding Non-Deliverable Forwards in Forex Trading

A key point to note here is that because this is a non-deliverable swap, settlements between the counterparties are made in U.S. dollars, and not in Argentine pesos. Let’s say an Indian corporation wants to hedge its exposure to fluctuations in the INR/USD exchange rate. They enter into an NDF contract with a foreign counterparty, agreeing to exchange a certain amount of INR for USD at a fixed rate at the end of the contract term. With an option trade, a company that is exposed to exchange rate risk can rely on a similar agreement to a forward trade.

Understanding Forex NDF Contracts: A Comprehensive Guide

The interest rate differential reflects the disparity in interest rates between the countries and directly impacts the pricing of NDFs. Meanwhile, the company is prevented from being negatively affected by an unfavourable change to the exchange rate because they can rely on the minimum rate set in the option trade. With a forward trade, once one has been agreed to, both parties are contractually obliged to complete the agreed exchange of currencies. While there is a premium to be paid for taking out an option trade, the benefits provided by their optional nature are significant.

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• This transaction allows the company to hedge against its rupee exposure without handling the actual currency.
• They provide a way for market participants to gain exposure to these currencies without facing the liquidity constraints that may exist in the spot market.
• The interest rate differential reflects the disparity in interest rates between the countries and directly impacts the pricing of NDFs.
• If the rate increased to 6.5, the yuan has decreased in value (U.S. dollar increase), so the party who bought U.S. dollars is owed money.
• Swaps are commonly traded by more experienced investors—notably, institutional investors.

The notional amount is never exchanged, hence the name “non-deliverable.” Two parties agree to take opposite sides of a transaction for a set amount of money – at a contracted rate, in the case of a currency NDF. It also helps businesses to conduct trade with emerging markets in the absence of convertible and transferable currency and manage the exchange rate volatility. The settlement of NDFs mostly takes place in cash as per the agreement made between the two parties. Most non-deliverable forward uses the dollar in the largest NDF markets like the Chinese Yuan, Brazilian Real, South Korean Won, and New Taiwan Dollar. Additionally, NDF contracts are often used in emerging markets where the domestic currency is not widely traded.

Non-Deliverable Forward (NDF) Meaning, Structure, and Currencies

The base currency is usually the more liquid and more frequently traded currency (for example, US Dollar or Euros). BASF enters a 90-day MXN/EUR NDF contract with Deutsche Bank to sell 300 million MXN at an NDF rate of 21 MXN per EUR. The opaque OTC nature of NDF markets makes entering and exiting large positions more challenging.

Providing Liquidity and Price Discovery

The difference between the agreed-upon exchange rate and the prevailing exchange rate is calculated at the settlement date. If the INR has depreciated against the USD, the foreign counterparty pays the Indian corporation the difference. Conversely, if the INR has appreciated, the Indian corporation pays the counterparty.

How NDFs Contribute to Global Currency Markets

For example, the borrower wants dollars but wants to make repayments in euros. So, the borrower receives a dollar sum and repayments will still be calculated in dollars, but payment will be made in euros, using the current exchange rate at time of repayment. If in one month the rate is 6.3, the yuan has increased in value relative to the U.S. dollar. If the rate increased to 6.5, the yuan has decreased in value (U.S. dollar increase), so the party who bought U.S. dollars is owed money. The contract has no more FX delta or IR risk to pay or receive currencies after the determination date, but has FX delta (and a tiny IR risk) to the settlement currency between determination and maturity dates.

The more active banks quote NDFs from between one month to one year, although some would quote up to two years upon request. The most commonly traded NDF tenors are IMM dates, but banks also offer odd-dated NDFs. NDFs are typically quoted with the USD as the reference currency, and the settlement amount is also in USD. In practice, the settlement currency is almost always either the same as pay or the same as receive currency.

However, the opaque OTC structure also poses risks around counterparty credit, liquidity constraints, and operational issues. Understanding contract specifications and nuances across NDF providers is vital. Working with reputable banks and monitoring credit standing is key to risk management. Settlement of NDF contracts is subject to timing mismatches or errors, creating risk around execution of payments.

The contract has FX delta and interest rate risk in pay and receive currencies until the maturity date. In 1 month (maturity date or settlement date), I pay you USD 1 milion and receive from you EUR 1.2 million. Market liquidity is another critical factor in non-deliverable forwards pricing. Liquidity refers to the ease with which NDF contracts can be bought or sold in the market. Higher liquidity leads to tighter bid-ask spreads and lower transaction costs, making the NDF contracts more attractive to investors.

The settlement of an NDF is closer to that of a forward rate agreement (FRA) than to a traditional forward contract. Non-deliverable swaps are used by multi-national corporations to mitigate the risk that they may not be allowed to repatriate profits because of currency controls. They also use NDSs to hedge the risk of abrupt devaluation or depreciation in a restricted currency with little liquidity, and to avoid the prohibitive cost of exchanging currencies in the local market.

Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. To understand the topic and get more information, please read the related stock market articles below.

The largest NDF markets are in the Chinese yuan, Indian rupee, South Korean won, Taiwan dollar, and Brazilian real. Just write the bank account number and sign in the application form to authorise your bank to make payment in case of allotment. With respect to pricing, the theoretical price is still determined bythe forward points which are derived by the relative interest rates to term of the contract. The motivation is that for many currencies (e.g. Russian rouble, RUB), regulations make it difficult to execute a physical delivery FX forward, so instead people trade USD/RUB or EUR/RUB NDFs. Understanding the factors determining their pricing is essential for making informed decisions when entering into these agreements.