Non-Deliverable Forwards (NDFs) play a crucial role in the global currency markets, particularly for trading restricted or illiquid currencies. Whether you’re a trader managing currency exposure or an institutional investor seeking to hedge against foreign exchange risk, understanding how NDFs work can offer a strategic advantage.
What Is a Non-Deliverable Forward (NDF)?
Key Takeaways
- NDFs are cash-settled currency contracts used to hedge or speculate on foreign exchange movements.
- Primarily used in markets where currency convertibility is limited or restricted.
- No physical delivery of currency; only the difference between contract and market rate is exchanged.
Definition of NDF
A Non-Deliverable Forward is a forward contract that involves two parties agreeing to exchange the difference between a contracted NDF rate and the prevailing spot market rate on a future date—without the actual delivery of the underlying currency.
Importance in the Currency Market
NDFs provide access to otherwise inaccessible markets. They’re essential tools for managing exposures to currencies that are not freely traded, such as the Chinese yuan (CNY), Indian rupee (INR), or Brazilian real (BRL).
How Do NDFs Work?
Overview of NDF Contracts
An NDF consists of:
- Notional amount (the theoretical size of the contract)
- Base and quoted currencies
- Forward rate
- Settlement date
- Fixing date (when the spot rate is observed)
NDF Settlement Mechanism
At settlement, the net cash difference is exchanged in a convertible currency (usually USD), based on the deviation between the agreed forward rate and the fixing spot rate.
Example of NDF Trading
Suppose a trader enters a 3-month NDF contract on USD/INR with:
- Notional: $1,000,000
- Forward rate: 83.00
- Fixing rate (on settlement): 85.00
Settlement Amount = Notional × (Fixing Rate – Forward Rate)
= $1,000,000 × (85.00 – 83.00) = ₹2,000,000 (received in USD equivalent)
Why Use NDFs for Trading?
Hedging Currency Risk
Companies with exposure to restricted currencies can lock in future rates to protect profit margins.
Speculating on Currency Movements
Traders use NDFs to capitalize on anticipated central bank actions, interest rate changes, or geopolitical shifts in non-convertible currency markets.
Lack of Physical Delivery
No need for currency conversion or offshore accounts—only net settlement in a convertible currency, reducing logistical and regulatory complications.
Non-Deliverable Forward Example
Real-World Scenario
A multinational based in the U.S. anticipates receiving Indian rupees in 90 days. To hedge against INR depreciation, it enters an NDF to sell INR forward against USD.
How NDF Settlements Occur
On the fixing date, the prevailing spot rate is compared to the forward rate. The difference is calculated in USD, and a one-way cash settlement is made.
When Are NDFs Typically Used?
Emerging Markets and Volatile Currencies
NDFs are ideal for managing exposure to currencies like the Colombian peso (COP), Korean won (KRW), or Philippine peso (PHP).
In Countries with Currency Controls
NDFs offer offshore access to currencies that are tightly regulated or non-convertible in domestic markets.
For Hedging Political or Economic Risks
In politically unstable or inflation-prone economies, NDFs allow firms to hedge against sharp currency devaluations.
NDF vs Forward Contracts
| Feature | NDF | Traditional Forward |
| Delivery | No physical delivery | Physical settlement |
| Usage | Restricted currencies | Freely traded currencies |
| Settlement | Cash in convertible currency | Currency exchange |
| Regulation | Often OTC | Exchange-traded or OTC |
Key Differences in Structure
While both are forward contracts, NDFs don’t involve delivery, making them suitable for currencies under capital control.
Settlements and Delivery
Traditional forwards require actual currency exchange, whereas NDFs only involve a net cash settlement.
NDF Advantages over Forward Contracts
- Flexibility in restricted markets
- Simplified cash settlement
- Reduced regulatory burden
Main Participants in the NDF Market
Financial Institutions and Hedge Funds
Large banks and hedge funds use NDFs for proprietary trading and risk management.
Central Banks and Corporations
Governments and multinational corporations use NDFs to stabilize currencies and hedge balance sheet exposure.
Risks of NDFs
Counterparty Risk
As OTC instruments, NDFs carry the risk that one party may default on the settlement obligation.
Market Risk
Currency volatility can lead to significant gains or losses depending on rate movements and contract size.
Regulatory and Compliance Risks
NDFs may be subject to specific reporting, capital adequacy, or margin requirements, depending on jurisdiction.
NDF Currencies
Commonly Traded NDF Currencies
- Chinese yuan (CNY)
- Indian rupee (INR)
- South Korean won (KRW)
- Brazilian real (BRL)
Currencies with High Liquidity in NDFs
USD-based NDFs on INR, CNY, and KRW typically offer tighter spreads and deeper liquidity pools.
How Are NDF Contracts Settled?
Cash Settlement Process
Settlement is made in a convertible currency, usually USD, based on the difference between the forward and fixing rates.
Calculation of Settlement Amount
Formula:
Settlement Amount = Notional × (Fixing Rate – Forward Rate)
Paid or received depending on directional exposure.
NDFs vs Currency Swaps
| Feature | NDF | Currency Swap |
| Delivery | Cash-settled | Exchange of principal and interest |
| Tenor | Typically short-term | Short to long-term |
| Purpose | Hedging/speculation | Hedging cash flows or funding |
Key Differences in Functionality
NDFs are point-in-time hedging instruments, while currency swaps manage ongoing cash flows between two currencies.
When to Choose NDFs Over Currency Swaps
Use NDFs when short-term exposure to non-convertible currencies must be hedged without physical currency movement.
What Is the Purpose of Using an NDF Contract?
Protecting Against Currency Fluctuations
Corporations use NDFs to lock in rates for payments and receivables, reducing exposure to FX volatility.
Managing Unsettled Markets
NDFs provide access to financial hedging in jurisdictions where traditional FX tools are unavailable or restricted.
Conclusion: Is NDF Trading Right for You?
NDFs are tools for strategic management of risks in restricted currency markets. With the flexibility, efficiency, and accessibility allowed for otherwise-close markets, NDFs remain an option to hedge business exposures or speculate against macroeconomic movements. Yet, certain fundamentals-the risk involved, the counterparties to the transaction, and the regulatory environment fashioning the NDF arrangement-must be studied before any such contracts are entered into.
Frequently Asked Questions
What is the main advantage of an NDF?
The primary advantage is the ability to hedge currency exposure in markets where direct currency trading or delivery is restricted.
How do NDFs differ from FX forwards?
NDFs are settled in cash without physical delivery, making them suitable for non-convertible currencies. FX forwards involve actual currency exchange.
Can NDFs be used for speculation?
Yes, traders use NDFs to speculate on expected changes in currency values, especially in emerging or regulated markets.
What risks should traders be aware of when using NDFs?
Key risks include market volatility, counterparty default, and changes in regulatory environments impacting contract enforceability.