A Non-Deliverable Forward (NDF) helps you manage your currency exposure against currencies not easily traded on the international FX market. This can be due to government restrictions or the absence of a deliverable forward market. Unlike standard forward contracts, NDF is cash-settled, meaning you don't exchange currency at maturity.
How they work
Like a fixed forward contract, you fix an NDF for an agreed amount of the currency for a specific due date at a defined forward rate. However, there is no physical settlement of the currencies in the NDF contract, and the notional amount is never exchanged.
On the due date, the set forward rate is compared with the fixing rate. This can be the daily rate fixed by the central bank of the non-convertible/partially convertible currency (available on Reuters reference pages) or an average rate published by several banks.
The difference between the pre-decided exchange rate and the fixing rate is cash-settled in a fully convertible currency (also called the fixing or settlement currency), such as USD, GBP, EUR, or CHF, on the due date. Meaning you will either pay or receive the difference at maturity.
Benefits of NDFs
- Protection: Protects your balance sheet from changes in value due to currency fluctuations when not needed to make a payment.
- Liquidity: Provides increased market liquidity in restricted currency markets.
- Customised: NDFs are flexible, as maturity dates and notional amounts can be tailored to meet your business needs and objectives.
- Certainty: You secure an FX rate, irrespective of market conditions. This helps you budget more accurately, reduce the impact of volatility on your costs, and stay relaxed.
- Visibility: Provides visibility of future payments and collections, enabling you to better manage your future global cash flows and budgeting.
Limitations
Irrespective of the many benefits NDFs offer, here are a few limitations that you need to consider:
- Variable outcomes: You may incur a loss and have to pay the difference in the settlement currency, depending on the fixing rate on the settlement date.
- Margin call: If the spot market moves unfavourably, you may be margin called to cover the out-of-the-money position.
- Loss of opportunity: You will lose the opportunity if the currency moves in your favour between the trade date and the maturity.
- Extra costs: You may incur additional costs due to cancellations or amendments to the NDF.
Costs
Like other forward contracts, the cost of the contract depends on the duration, currency pair and amount.
Disclaimer
Ebury offers Non-Deliverable Forward Contracts through a regulated entity. Click here to learn more or contact your dedicated account manager.
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