Monday, June 17, 2024

NDF

A Non-Deliverable Forward (NDF) is a forward or futures contract in which the parties settle the difference between an agreed NDF price and the prevailing spot market price at the end of the agreement.

A non-deliverable forward (NDF) is a two-party currency derivatives contract that exchanges cash flows between the NDF and the prevailing spot rate. One party will pay the other party the difference resulting from this exchange.

Cash flow = (NDF exchange rate – spot exchange rate) * nominal amount

The largest NDF markets are Chinese Yuan, Indian Rupee, Korean Won, New Taiwan Dollar and Brazilian Real.

Other popular markets are Chilean Peso, Colombian Peso, Indonesian Rupiah, Malaysian Ringgit, Philippine Peso, and Taiwan New Dollar.

What is NDF?

NDF is an over-the-counter (OTC) transaction that functions like a forward contract on a non-convertible currency, allowing traders to hedge market risks that cannot be traded directly in the underlying physical currency.

The contract is not delivered in the base currency pair but is settled by a net payment in the convertible currency proportional to the difference between the agreed forward rate and the subsequently realized spot rate.

This fixing price is the standard market rate set on the fixing date, which for most currencies is two days before the forward value date.

The basis for a fixed exchange rate varies by currency, but can be the official rate set by the country’s central bank or other institution, or it can be the average of interbank prices at a given time.

NDFs differ from deliverable forward contracts in that they are traded outside the direct jurisdiction of the respective monetary authorities and their pricing is not subject to domestic interest rates.

Most NDF transactions are settled in US dollars, although it is also possible to exchange NDF currencies into other convertible currencies such as Euros, British Pounds and Japanese Yen.

How does NDF work?

All NDF contracts specify the currency pair, nominal amount, pricing date, settlement date and NDF exchange rate, and stipulate that the transaction will be completed at the spot exchange rate on the pricing date.

The pricing date is the date on which the difference between the current spot market rate and the agreed rate is calculated. The settlement date is the date on which the balance is due to be paid by the payee.

If one party agrees to buy RMB (sell US dollars) and the other party agrees to buy US dollars (sell RMB), then there may be a non-deliverable forward between the two parties.

They agreed to exchange $1 million for $7.00. The date will be confirmed within a month and settlement will take place shortly after.

If the exchange rate within a month is 6.9, the RMB has appreciated relative to the US dollar. The party who bought RMB owes money.

If the exchange rate rises to 7.1, the RMB will depreciate (the US dollar will appreciate), so the party buying US dollars will owe money.

If you want to learn more foreign exchange trading knowledge, please click: Trading Education.

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