Context:
“The NDF(non-deliverable forward) was showing opening at 88. Since Ifelt that RBIwill surely intervene, Iasked exporters to cover it at whatever level they got above 87.90. The intervention was very strong as the rupee rose to 87.41 before the fall to 87.60. RBImay have sold $1-2 billion to protect the rupee,” said Anil Kumar, head of treasury at Finrex Treasury Advisors.
Non Deliverable Forwards (NDFs)
Non Deliverable Forwards (NDFs) are financial contracts used for speculating or hedging against currency fluctuations in markets where currencies are not freely traded. They are widely used by companies and investors to manage currency risk in restricted or controlled foreign exchange markets.
How NDFs Work?
- Short term contracts
- The two parties agree on an exchange rate at some point in the future.
- Cash settlement
- No physical exchange of currencies. Settled in cash.
- Settlement process
- The difference between the agreed rate (contract rate) and the actual market rate at maturity is computed.
- A party that is at a disadvantage pays the difference to the counterparty. .
- Pricing in USD
- Most NDFs are priced and settled in U.S. dollars. .
- Traded offshore
- NDFs are commonly traded in offshore financial markets, outside of the jurisdiction of the currency’s home country. .
Why NDFs Are Used?
- Used for hedging against currency risk by businesses that operate in countries with capital controls or restricted foreign exchange markets.
- Used by investors to bet on currency movements without needing access to the actual currencies.
- Access to restricted markets
- Investors cannot trade in a country’s currency directly because of regulatory restrictions can seek NDFs instead.
NDF Market & Applications
- Forex
- Against the volatility in the emerging economies, it has been used in hedging
- Commodities
- Some of the NDFs are commoditized and link the payments basis on price variation
- Most common currencies on NDF platforms:
- Chinese Yuan (CNY)
- Indian Rupee (INR)
- South Korean Won (KRW)
- Brazilian Real (BRL)
