What is: Non-Deliverable Forward (NDF)

What is Non-Deliverable Forward (NDF)

Non-Deliverable Forward (NDF) is a type of financial derivative contract that allows investors to hedge or speculate on the exchange rate between two currencies that are not freely tradable. NDFs are typically settled in cash rather than the actual delivery of the underlying currencies.

NDFs are commonly used in emerging markets where the local currency is not freely convertible. Investors use NDFs to protect themselves against currency risk or to speculate on the future movement of exchange rates.

The settlement of an NDF is based on the difference between the agreed-upon exchange rate and the prevailing market rate at the time of maturity. If the agreed-upon rate is higher than the market rate, the buyer of the NDF receives a cash settlement. If the agreed-upon rate is lower, the seller of the NDF receives a cash settlement.

NDFs are typically traded over-the-counter (OTC) and are not regulated by a central exchange. This makes them a flexible and customizable tool for managing currency risk in non-convertible currencies.

Investors in NDFs should be aware of the risks involved, including counterparty risk and market volatility. It is important to carefully consider the terms of the NDF contract and seek advice from a financial professional before entering into any NDF transactions.

Overall, Non-Deliverable Forwards are a valuable tool for investors looking to manage currency risk in non-convertible currencies. By understanding how NDFs work and the risks involved, investors can make informed decisions about using these derivatives in their investment strategies.