AN OVERVIEW OF THE NON-DELIVERABLE FORWARD NDF MARKET

HSBC Innovation Bank Limited does not provide Investment, Legal, Financial, Tax or any other kind of advice. Before entering into any foreign exchange transaction, you should seek advice from an independent Advisor, and only make investment decisions on the basis of your objectives, experience and resources. Similar to the global non deliverable forward market, the operational process of NDFs in India involves local entities engaging in contracts with foreign counterparts. These contracts stipulate the buying or selling of a specific amount https://www.xcritical.com/ of INR at a predetermined rate on a future date.

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NDFs are straightforward hedging tools, while NDSs combine immediate liquidity provision with future risk hedging, making each instrument uniquely suited to specific financial scenarios. An NDF is a currency derivatives contract between two parties designed to exchange cash flows based on the difference between the NDF and prevailing spot rates. Hence, to overcome this problem, an American company signs an NDF agreement with a financial institution while agreeing to exchange cash flows on a certain future date based on the prevailing spot rate of the Yuan. Instead, the only monetary transaction involves the difference between the prevailing spot rate and the rate initially agreed upon in the NDF contract. An NDF is a powerful tool for trading non-deliverable forward currencies that is not freely available in the spot market. By understanding how they work, their benefits and risks and how they differ from DFs, you can use them to diversify your portfolio, hedge your currency risks or speculate on the exchange rate movements of these currencies.

Offshore Currency Markets: Non-Deliverable Forwards (NDFs) in Asia

The settlement of an NDF is closer to that of a forward rate agreement (FRA) than to a traditional forward contract. NDFs are commonly used by businesses, investors, and financial institutions to hedge against currency fluctuations, especially in emerging markets. As a result, sell-side firms have seized the opportunity to develop NDF algos.

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BNP Paribas’ NDF algos take advantage of fragmented external liquidity sources, but also tap into the bank’s local market franchise and internalise the flow by utilising pools of internal liquidity sources. The product removes the operational issues that new entrants need to concern themselves with, such as fixing and settlement dates, allowing clients to concentrate on their market exposure. At Finalto, the access to emerging currencies NDFs are offered to market players via its electronic trading systems and real-time reporting.

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FXall is the flexible electronic trading platform that delivers choice, agility, efficiency and confidence that traders want, across liquidity access to straight-through processing. An agreement that allows you to lock in a rate of exchange for a pre-agreed period of time, similar to a Forward or the far leg of a Swap Contract. The borrower could, in theory, enter into NDF contracts directly and borrow in dollars separately and achieve the same result.

Risks Associated with NDF Trading

This means that counterparties settle the difference between contracted NDF price and the prevailing spot price. The profit or loss is calculated on the notional amount of the agreement by taking the difference between the agreed-upon rate and the spot rate at the time of settlement. In certain situations, the rates derived from synthetic foreign currency loans via NDFs might be more favourable than directly borrowing in foreign currency. While this mechanism mirrors a secondary currency loan settled in dollars, it introduces basis risk for the borrower. This risk stems from potential discrepancies between the swap market’s exchange rate and the home market’s rate.

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Consequently, the transaction based on NDF tends to be affordable and cost-effective compared to other forward contracts. In addition, an NDF has the characteristics of getting custom contract terms as per the needs of parties involved, like settlement date, reference exchange rate, and notional amount. An NDF is a cash-settled forward contract, traded over-the-counter for currenciesthat are not fully convertible. There is a need to study non-deliverable forwards (NDF) as ahedging tool and various other aspects of NDF market in the Indian context. The objective of thispaper is to explore and explain the concept of NDFs, since many people do not understand thereasons for its existence and how it works. This study discusses the non-deliverable forward (NDF) markets in general and presents some analysis about the RMB NDF market in particular.

We discover that the foreign exchange forward premium (RMB/US$) becomes discount for various maturities of the NDF after November 13, 2002. The use of RMB NDF will likely continue to rise as more foreign investors have a bigger stake in doing business in China. If a business has hedged against currency risk that it is exposed to with an option trade it can also benefit if exchange rates change favourably. This is what currency risk management is all about and the result of a non-deliverable forward trade is effectively the same as with a normal forward trade.

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A DF is usually used for currencies that are freely convertible and traded in the spot market, such as the euro (EUR), British pound (GBP) or Japanese yen (JPY). Predicting how currencies will change in the future is very important for pricing Non deliverable forwards (NDFs). Traders and others in the market look at things like how economies are doing, big world events, and what central banks are planning to figure out if a currency might go up or down. Unlike traditional forward contracts, NDFs don’t necessitate physical delivery of the underlying currencies. Instead, a cash settlement is given in a free tradable currency – usually U.S dollars.

NDFs are customizable, offering leverage and flexibility to suit different needs and preferences. NDFs offer flexibility, allowing participants to hedge currency risk in markets where traditional currency exchange is limited or unavailable. NDF markets are developed in response to restrictions that constrained access to onshore markets. When the time comes, they simply trade at the spot rate instead and benefit by doing so.

It was given the authority to regulate the swap market under the  Dodd-Frank Wall Street Reform and Consumer Protection Act. FX Aggregator is reliable and cost-efficient, giving you seamless execution to the deepest market liquidity pools. The launch of NDF Matching is the first phase of our replatforming initiative, which sees the migration of our FX venues onto our common core technology platform. This will provide customers with better performance and improved functionality, and support increased product innovation.

There are also active markets using the euro, the Japanese yen and, to a lesser extent, the British pound and the Swiss franc. As the NDF market has become electronically mature in recent years, BRL algos have become the latest innovation on the market. Asia accounts for three of the top four NDF currencies by volume globally, according to the Bank for International Settlements (BIS) Triennial Central Bank Survey. The Indian Rupee, Korean Won, and New Taiwan Dollar accounted for 55% of total daily global NDF turnover of $258 billion as of April 2019, while onshore Renminbi accounts for another 5% of global NDF turnover. Achieve unmatched margin, capital and operational efficiencies, and enhanced risk management, across your deliverable and non-deliverable OTC FX.

They have given firms the ability to hedge foreign exchange risk in currencies that were once unavailable to them. They also allow investors the opportunity to trade these currencies to generate return. The expansion allows clients to use effective hedging tools for trading OTC derivatives contracts and leverage products in line with regulations in respective countries.

Once the company has its forward trade it can then wait until it receives payment which it can convert back into its domestic currency through the forward trade provider under the agreement they have made. A typical example of currency risk in business is when a company makes a sale in a foreign currency for which payment will be received at a later date. In the intervening period, exchange rates could change unfavourably, causing the amount they ultimately receive to be less. ‍Non-Deliverable Forwards (NDFs) provide a flexible and efficient means of managing currency risk and accessing markets with restrictions. Understanding how NDFs work and their applications is essential for businesses, investors, and financial institutions operating in global markets. Incorporating NDFs into a comprehensive risk management strategy can mitigate the impact of currency fluctuations, providing stability and opportunities for growth in the ever-evolving world of Forex trading.

• If we go back to our example of a company receiving funds in a foreign currency, this will be the amount that they are expecting to be paid in the foreign currency.
• In our example, this could be the forward rate on a date in the future when the company will receive payment.
• The settlement of an NDF is closer to that of a forward rate agreement (FRA) than to a traditional forward contract.
• NDFs provide liquidity and price discovery for currencies with limited or no spot market activity.
• An agreement that allows you to lock in a rate of exchange for a pre-agreed period of time, similar to a Forward or the far leg of a Swap Contract.

NDFs are also known as forward contracts for differences (FCD).[1] NDFs are prevalent in some countries where forward FX trading has been banned by the government (usually as a means to prevent exchange rate volatility). It also helps businesses to conduct trade with emerging markets in the absence of convertible and transferable currency and manage the exchange rate volatility. The settlement of NDFs mostly takes place in cash as per the agreement made between the two parties. Most non-deliverable forward uses the dollar in the largest NDF markets like the Chinese Yuan, Brazilian Real, South Korean Won, and New Taiwan Dollar.