Non-Deliverable Forwards & NDF Markets Leave a comment

Predicting how currencies will change in the future is very important for pricing Non deliverable forwards (NDFs). Traders and others in the market look at things like how economies are doing, big world events, and https://www.xcritical.com/ what central banks are planning to figure out if a currency might go up or down. A crucial point is that the company in question does not lose money as a result of an unfavourable change to the exchange rate.

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

We are the first one to present the NDF market and examine the behavior of the RMB/dollar NDF rates for this market. NDFs allow you to trade currencies that are not available in the spot market, hedge your currency risks and avoid delivery risk. A deliverable forward (DF) is a forward contract involving the actual delivery of the underlying currency at non deliverable forward example maturity.

How a Normal Forward Trade Works

• If the exchange rate has moved unfavourably, meaning that the company receives less than expected at the spot rate, the provider of the NDF contract will reimburse them by the appropriate amount.
• The settlement of an NDF is closer to that of a forward rate agreement (FRA) than to a traditional forward contract.
• We introduce people to the world of trading currencies, both fiat and crypto, through our non-drowsy educational content and tools.
• For Indian companies, NDFs offer a means to hedge against currency fluctuations when engaging in international trade.
• We are the first one to present the NDF market and examine the behavior of the RMB/dollar NDF rates for this market.

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. If they think a currency might go down, the NDF price will be lower to cover the risk of losing money. NDFs enable Indian companies to effectively mitigate currency risk, primarily in areas where the INR is subject to changing volatility or restraints imposed by the regulatory framework on currency convertibility. When we talk about an offshore market, it means trading in a place outside of where the trader lives.

Trade credit behavior of Korean small and medium sized enterprises during the 1997 financial crisis

A non-deliverable swap (NDS) is an exchange of different currencies, between a major currency and a minor currency, which is restricted. 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.

NDF Matching builds on the strengths of Matching with the addition of enhanced clearing capabilities

An NDF is a financial contract that allows parties to lock in a currency exchange rate, with the rate difference settled in cash upon maturity rather than exchanging the currencies. NDFs gained massive popularity during the 1990s among businesses seeking a hedging mechanism against low-liquidity currencies. For instance, a company importing goods from a country with currency restrictions could use NDFs to lock in a favourable exchange rate, mitigating potential foreign exchange risk. The article will highlight the key characteristics of a Non-Deliverable Forward (NDF) and discuss its advantages as an investment vehicle.

Why Should A Broker Offer NDF Trading?

What non-deliverable forwards provide is the opportunity to protect a business (or an investor or individual if needs be) that is exposed to currency risk in a currency for which a normal forward trade is not possible. Non-deliverable forwards can be used where it is not actually possible to carry out a physical exchange of currencies in the same way as normal forward trade. Also known as an outright forward contract, a normal forward trade is used to lock the exchange rate for a future date. Currency risk is the risk that a business, investor or individual will lose money as a result of a change to exchange rates. Consequently, since NDF is a “non-cash”, off-balance-sheet item and since the principal sums do not move, NDF bears much lower counter-party risk.

What Alternatives to Forward Trades are There?

Lastly, we will outline several ways to negate or cancel an existing forward position that is no longer needed. If the company goes to a forward trade provider, that organisation will fix the exchange rate for the date on which the company receives its payment. The exchange rate is calculated according to the forward rate, which can be thought of as the current spot rate adjusted to a future date. Once the company has its forward trade it can then wait until it receives payment which it can convert back into its domestic currency through the forward trade provider under the agreement they have made.

Foreign Exchange – Non-Deliverable Forwards

Determining the price of non deliverable forward contracts is a detailed process that takes into account many factors and a special formula for NDF pricing. One important factor is the difference in interest rates between the two currencies in the contract. This difference shows how much the interest rates vary between the countries and affects how NDFs are priced. Similar to the global non deliverable forward market, the operational process of NDFs in India involves local entities engaging in contracts with foreign counterparts. These contracts stipulate the buying or selling of a specific amount of INR at a predetermined rate on a future date. Settlements for these contracts occur in a convertible currency, typically the US dollar.

Co-movements between Shanghai Composite Index and some fund sectors in China

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. When making a settlement between the two currencies involved, value is based on the spot rate and the exchange rate listed in the swap contract. In order to bring the NDS to a settlement, one of the parties involved needs to pay the other the difference in the rates between the time of the contract’s origination and its settlement. An NDF is a currency derivatives contract between two parties designed to exchange cash flows based on the difference between the NDF and prevailing spot rates.

A UK company selling into Brazil needs to protect the sterling-equivalent of revenues in local currency, the Brazilian Real. Due to currency restrictions, a Non-Deliverable Forward is used to lock-in an exchange rate. 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.

Non-deliverable forwards are most useful and most essential where currency risk is posed by a non-convertible currency or a currency with low liquidity. In these currencies, it is not possible to actually exchange the full amount on which the deal is based through a normal forward trade. An NDF essentially provides the same protection as a forward trade without a full exchange of currencies taking place. A swap is a financial contract involving two parties who exchange the cash flows or liabilities from two different financial instruments. Most contracts like this involve cash flows based on a notional principal amount related to a loan or bond. In normal practice, one can trade NDFs without any physical exchange of currency in a decentralized market.

For example, if a country’s currency is restricted from moving offshore, it won’t be possible to settle the transaction in that currency with someone outside the restricted country. However, the two parties can settle the NDF by converting all profits and losses on the contract to a freely traded currency. They can then pay each other the profits/losses in that freely traded currency.

OTC market provides certain advantages to traders like negotiation and customization of terms contained in NDF contracts like settlement method, notional amount, currency pair, and maturity date. 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. This is what currency risk management is all about and the result of a non-deliverable forward trade is effectively the same as with a normal forward trade. While the company has to sacrifice the possibility of gaining from a favourable change to the exchange rate, they are protected against an unfavourable change to the exchange rate.

Where HSBC Innovation Banking markets any foreign exchange (FX) products, it does so a distributor of such products, acting as agent for HSBC UK Bank plc and/or HSBC Bank plc. An agreement that allows you to lock in a rate of exchange for a pre-agreed period of time, similar to a Forward or the far leg of a Swap Contract. Note that the Investopedia article you cite is mistaken (no surprise, it’s a very bad source of information) in that you look at the spot rate on determination date, not on settlement date. In practice, the settlement currency is almost always either the same as pay or the same as receive currency. E.g., you swap EUR for RUB and settle in EUR, or you swap USD for BRL and settle in USD. The contract has FX delta and interest rate risk in pay and receive currencies until the maturity date.

For Indian companies, NDFs offer a means to hedge against currency fluctuations when engaging in international trade. This strategy allows them to secure exchange rates, safeguarding their profits from adverse currency shifts. If we go back to the example of a business that will receive payment for a sale it has made in a foreign currency at a later date, we can see how a forward trade is used to eliminate currency risk. Distinguishing itself from traditional providers, B2Broker has innovatively structured its NDFs as Contracts For Difference (CFDs). While standard NDFs often come with a T+30 settlement period, B2Broker ensures clients can access settlements as CFD contracts on the subsequent business day.

The notional amount, representing the face value, isn’t physically exchanged. Instead, the only monetary transaction involves the difference between the prevailing spot rate and the rate initially agreed upon in the NDF contract. Non deliverable forwards (NDF) are a unique instrument that helps manage currency risk. Simply put, NDF makes it possible to hedge currency exchange rate movements between two currencies without exchanging either of them physically. It plays a significant role worldwide, especially in emerging markets and developing economies, as currency fluctuations represent major uncertainties and threats. NDFs are settled with cash, meaning the notional amount is never physically exchanged.

Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about investment topics ranging from traditional asset classes and derivatives to alternatives like cryptocurrency and real estate. Her work has been published on sites like Quicken and the crypto exchange Bybit. NDFs typically involve currencies from emerging markets with restricted convertibility, such as the Brazilian Real, Indian Rupee, or Chinese Yuan. NDFs are often prevalent in emerging markets with currency controls or currency convertibility restrictions. The “onshore market” is the local currency market of the country where a trader legally belongs.