A non deliverable forward (NDF) is a forward contract or currency which does not entail physical delivery. And is an exchange traded derivative that focuses on the exchange rate of a particular currency. It entails an operation normally used for hedging instruments, because the contractor guarantees a future exchange rate for the base currency of the contract.
In the event that an NDF currency exchange is not established, it will be traded in the over-the-counter market. Capital controls implemented on emerging currencies, can not be procured offshore in the normal transactions for future delivery, thus necessitating the development of non-deliverable forward markets. Most of the net settlement of the NDF are carried out in U.S. dollars.
The contracts usually take effect between the two parties, and forward short-term currency transactions are settled by cash. The settlement date in the NDF contract between the parties also plays a part in determining the profit or loss, depending on the difference between the prevailing spot exchange rate and the date payment is made.
Non deliverable fowards’ main conditions include; Notional – the agreement between the parties is conducted on the basis of face value. And more importantly, both must ensure replacement of the principal notional currency amount.
Date Rate Determination: NDF is determined on the difference between the basic rate and spot rate. Settlement date: the day of delivery plays a key role.
NDF contract rate: An agreement on the rate equivalent to exchange rate futures takes effect. The prevailing spot rate as of the determination date will be made based on the Reuters reference.
In the event that the rates are unavailable, they can alternatively be derived from the typical reference currency markets where the rate is determined.
If purchase is made at term, and the price rises, you get the credit of the difference, since it is paid by currency, at maturity. Conversely, if the sale is concluded, you get credit if the price of the currency falls, since its price is higher than the market price.
It is noteworthy that there is no physical delivery of the concerned currency (or any other foreign currency involved in the operation) by only paying the difference between the agreed rate or the rate on the day prior to expiration of the operation (adjustment).
NDF prices are typically between the U.S. dollar rate and the reference currency.
Typically, NDF currencies will not be reflected in the balance sheet, because there is no small delivery of the principal. NDF is a short-term trading, hence the parties undertaking an agreement may cancel the delivery by the prevailing exchange rate.