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Non Deliverable Forwards

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Published: 18th August 2011 by William Webster

Non deliverable forward (NDF)

What is a non deliverable forward? It is a forward foreign exchange contract but instead of there being physical delivery at maturity of the currency pair the counterparties settle the transaction by a single net payment in the convertible currency. This payment represents the profit or loss on the trade.

NDFs are used when a currency is not freely convertible. That is where the authorities only permit the exchange of the domestic currency through the central bank at an official spot rate. The proceeds of which may then be taken out of the country.

If an exporter invoices in a non-convertible currency the invoice amount will eventually need to be sold (normally for USD) through official channels.

As a result of the fluctuation of the spot rate the exporter may receive more or less USD than expected and is therefore subject to currency risk. This risk can be hedged with a NDF.

Let's look at an example:

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