However, there will still be a good amount of demand for NDFs from those looking to speculate. Especially for NDFs, there can be quite a lot of volatility in these types of pairs so it can be an interesting addition to a well risk managed portfolio. NDFs are primarily used to hedge against currency risk in the near term for corporations that have exposure to developing market currencies which are often subject to high volatility. For example, an American firm with subsidiary in India that earns revenues what is ndf in rupees but reports in USD can hedge the EUR/INR risk by using NDFs.

Non-Deliverable Currencies in 2024: A Comprehensive List

This cash settlement feature makes NDFs particularly useful for hedging exposure to currencies that face trading restrictions or are not easily accessible in international markets. In contrast, DFs are more suitable for entities that genuinely need the physical delivery of the currency, such as businesses involved in international trade or investments. In conclusion, a Non-Deliverable Forward (NDF) contract is a derivative instrument used to hedge against currency risk in markets where the local currency is non-convertible or subject to restrictions. It allows for the exchange of one currency for another at a future date at a pre-determined exchange rate, with cash https://www.xcritical.com/ settlement instead of physical delivery.

• Banks also structure NDFs flexibly to meet client business requirements in terms of size, dates, and benchmarks.
• Delayed confirmations, increased cancellations and amendments raise the likelihood of operational issues in OTC NDF markets compared to exchange trading.
• The difference in interest rates between the currencies in an NDF drive its pricing to a large extent.
• They can then pay each other the profits/losses in that freely traded currency.
• The total cost of the machinery is 10 million Chinese Yuan (CNY), and the payment is due in six months.

Understand NDFs to Navigate Forex

All NDF contracts set out the currency pair, notional amount, fixing date, settlement date, and NDF rate, and stipulate that the prevailing spot rate on the fixing date be used to conclude the transaction. Unlike in an NDF contract in which the difference between the NDF rate and the fixing rate gets settled in cash, a deliverable forward currency involves the delivery of the settlement currency when the contract matures. The loss or profit gets calculated depending on the notional amount of the agreement. That’s the difference between the spot and pre-agreed rates upon settlement. However, the notional amount in a non-deliverable forward contract is never exchangeable.

Advantages of Non-Deliverable Forward Contracts

Delayed confirmations, increased cancellations and amendments raise the likelihood of operational issues in OTC NDF markets compared to exchange trading. We introduce people to the world of trading currencies, both fiat and crypto, through our non-drowsy educational content and tools. We’re also a community of traders that support each other on our daily trading journey. Forex trading involves significant risk of loss and is not suitable for all investors.

Access to Restricted Currencies

One primary use is to hedge against currency risk in countries where the currency is not freely convertible. For example, a multinational corporation operating in a country with capital controls may use NDF contracts to protect against potential losses due to adverse currency movements. NDFs allow you to trade currencies that are not available in the spot market, hedge your currency risks and avoid delivery risk. NDFs allow hedging and speculation for currencies with high exchange rate risk or potential returns.

Hedge Against Risk With Non Deliverable Currencies

BASF, a German chemical company, operates a manufacturing facility in Mexico. It expects to receive 300 million Mexican pesos in 90 days from customer sales in Mexico. BASF wants to hedge this incoming MXN exposure to EUR, its home currency. NDFs traded offshore may not be subjected to the same regulations as onshore currency trading.

Advantages and Disadvantages of NDF Contracts

Instead, they are negotiated and agreed upon between two parties, usually through a bank or a broker. The terms of the NDF contract include the notional amount (the size of the contract), the reference currency, the settlement currency, and the fixing date. The main difference between forward and NDF is that in a standard forward contract, there is actual delivery of the underlying currencies on the settlement date. In contrast, an NDF involves cash settlement of the difference between the agreed and prevailing market rates, without any physical exchange of currencies. For example, if a company operates in a country with strict rules on currency exchange, it might use an NDF to protect itself from losing money due to changes in currency values.

Corporations can fine tune their hedging needs via tailored NDF contracts, unlike standardized futures contracts. Banks also structure NDFs flexibly to meet client business requirements in terms of size, dates, and benchmarks. 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. NDFs are primarily used in markets where the currency is not freely tradable or faces certain restrictions. There are also active markets using the euro, the Japanese yen and, to a lesser extent, the British pound and the Swiss franc.

What Is a Non-Deliverable Forward Contract?

It is a contract to pay the difference between an agreed-upon currency exchange rate and the real rate on a future date, using money rather than exchanging physical currencies. A non-deliverable forward (NDF) is a two-party currency derivatives contract to exchange cash flows between the NDF and prevailing spot rates. One party will pay the other the difference resulting from this exchange. The good thing about NDFs is that they are available in a vast range of currencies and offer means of hedging foreign exchange risk in markets that don’t support the physical delivery of money. NDF contracts are primarily used to hedge against currency risk in markets where the local currency is non-convertible or subject to significant restrictions.

Additionally, NDFs promote financial innovation and inclusion by offering new products and opportunities for financial intermediaries and end-users. The global financial industry is replete with corporations, investors, and traders seeking to hedge exposure to illiquid or restricted currencies. By offering NDF trading, brokers can attract this substantial and often underserved client base. Given the specialised nature of NDFs, these clients are also likely to be more informed and committed, leading to higher trading volumes and, consequently, increased brokerage revenues.

Tamta’s writing is both professional and relatable, ensuring her readers gain valuable insight and knowledge. NDFs can be used to create a foreign currency loan in a currency, which may not be of interest to the lender. The base currency is usually the more liquid and more frequently traded currency (for example, US Dollar or Euros). Vincent is a writer and researcher with an interest in finance, banking, startups, and remittance.

So, for example, in a forward contract involving a currency pair of USD/AUD, there would be a physical exchange of USD equivalent to AUD. To understand what NDF is, let’s use a Non-Deliverable Forward example. In an NDF deal, two parties agree to swap currencies at a set rate on a later date, but they don’t actually exchange the currencies. This happens because those special currencies can’t be easily traded, so handing them over is hard or even impossible.

NDF contracts are derivative instruments that allow traders to speculate on the future value of a currency. Unlike traditional forex contracts, NDFs are settled in a different currency, typically the US dollar (USD), rather than the underlying currency being traded. This feature makes NDF contracts particularly useful when trading in countries with restricted currency convertibility or where the currency is not freely traded on the global market. The NDF market operates by allowing parties to hedge or speculate on the movement of currencies that restrict their convertibility. The contract’s profit or loss is determined based on the difference between the agreed exchange rate in the NDF contract and the prevailing market rate at the time of settlement. A Non-Deliverable Forward (NDF) is a financial derivative used in forex markets.

The only cash that actually switches hands is the difference between the prevailing spot rate and the rate agreed upon in the NDF contract. One party pays another the difference between the NDF rate and the spot rate; the payment is usually in U.S. dollars. Besides, NDFs get traded over the counter (OTC), encouraging the flexibility of terms to satisfy the needs of both parties involved. Unlike a deliverable forward contract which involves the exchange of assets or currency at an agreed rate and future date, a non-deliverable forward (NDF) requires cash flow, not tangible assets. Another good thing about forward contracts is that it operates under non-standardized terms. That means the involved parties can tailor them to a specific amount and for any delivery period or maturity.

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. In certain situations, the rates derived from synthetic foreign currency loans via NDFs might be more favourable than directly borrowing in foreign currency. While this mechanism mirrors a secondary currency loan settled in dollars, it introduces basis risk for the borrower. This risk stems from potential discrepancies between the swap market’s exchange rate and the home market’s rate. Consider a scenario where a borrower seeks a loan in dollars but wishes to repay in euros.

Secondary data files make up all the data files, other than the primary data file. Some databases may not have any secondary data files, while others have several secondary data files. If there’s a firm who has a Brazilian office, that firm will have to pay salaries in Brazilian to its local employees. Because an NDF is essentially a forward contract, it makes it much easier to hedge against the less available currency. In fact, to understand the fundamentals of non-deliverable forward vs. forward-deliverable contracts, you must know what forward contracts are. So, this guide will first elaborate on what forward contracts as well as the differences between deliverable and non-deliverable forward contracts.

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. That said, non-deliverable forwards are not limited to illiquid markets or currencies. They can be used by parties looking to hedge or expose themselves to a particular asset, but who are not interested in delivering or receiving the underlying product.

They are most frequently quoted and settled in U.S. dollars and have become a popular instrument since the 1990s for corporations seeking to hedge exposure to illiquid currencies. More people are becoming interested in NDFs, but there is a caveat as in a lot of cases the demand can be increasingly made up of people hedging rather than looking to speculate on the currency. A big advantage for companies with foreign offices is that NDFs make it possible to hedge the exchange rate risk of an expansion.

This binding contract locks in an exchange rate for the sale of the purchase of a specific currency on a predetermined future date. In other words, it is a customizable currency-hedging tool without upfront margin payment. A forward contract is a mutual agreement in the foreign exchange market where a seller and buyer agree to sell or buy an underlying asset at a pre-established price at a future date. That’s why it’s also known as a forward foreign exchange contract (FEC). The current spot exchange rate and market forecasts of where the spot rate will be on the maturity date impact NDF levels. NDFs are primarily traded in over-the-counter markets between authorized financial institutions and large corporations.