Non-Deliverable Forward

A cash-settled forward for restricted currencies

A forward on a currency that cannot leave its own borders. The economics are those of an ordinary forward — a rate agreed today for a date in the future — but nothing is ever delivered in the restricted currency. Instead the two sides compare their agreed rate with an official fixing on the fixing date and settle the difference as a single payment in a convertible currency, almost always US dollars. That one design change is what lets an offshore investor take a position in a currency it is not permitted to hold.

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The lesson

1. What it is

A non-deliverable forward is an FX forward that never delivers the underlying currency. At maturity the parties settle the difference between the agreed rate and an official fixing, paid in a convertible currency such as US dollars.

The deepest NDF markets are in the Korean won, Indian rupee, Brazilian real and Taiwan dollar, and the overwhelming majority settle in US dollars.

2. How it works

Two parties agree a rate on a notional amount. On the fixing date an official reference rate is published; whichever side is out of the money pays the difference in dollars. Where the notional is a dollar amount and the pair is quoted as units of the restricted currency per dollar, the payment is notional × (fixing − contract rate) ÷ fixing — the gain arises in the restricted currency and is converted to dollars at the same fixing that produced it. The restricted currency itself never moves.

3. Why it’s used

Many emerging-market currencies sit behind capital controls that block delivery offshore. NDFs let companies and investors hedge or take positions in those currencies without local bank accounts or regulatory approval.

The market shrinks as controls ease. Renminbi NDF volumes fell away once a deliverable offshore renminbi market (CNH) developed and gave participants a way to settle physically.

4. Key terms

The fixing rate and its source (often a central bank or an industry benchmark), the settlement currency, the notional, and the gap between the fixing date and the settlement date a day or two later. That gap exists so the payment can be calculated once the fixing has printed.

Fixing sources are named in the confirmation rather than invented per trade — USD/BRL settles against PTAX, published by the Banco Central do Brasil, and the market works from standard EMTA template terms.

5. Risks to watch

The official fixing can differ from the rate a firm actually achieves onshore, leaving basis risk in the hedge. Fixings can also be suspended or redefined during a currency crisis, at which point documented fallbacks decide what the trade pays, and liquidity in these markets thins out quickly under stress.

Hedging a Brazilian bond position

A fund holds BRL 52,000,000 of Brazilian local bonds. In USD/BRL the dollar is the base currency, so the rate is reais per dollar.
Spot is 5.2000, so the position is worth $10,000,000. The fund buys $10,000,000 of a one-month USD/BRL NDF at 5.2000 — long dollars, short reais. The contract rate is simplified to spot to keep the arithmetic clear; a real one-month NDF prints above spot, because Brazilian interest rates sit well above dollar rates.
At the fixing the rate is 5.4000, so the bonds are now worth BRL 52,000,000 ÷ 5.4000 = $9,629,630.
The NDF pays $10,000,000 × (5.4000 − 5.2000) ÷ 5.4000 = $370,370, settled in dollars.
The hedged position is worth $9,629,630 + $370,370 = $10,000,000, unchanged in dollar terms.

No reais ever change hands. The profit arises as BRL 2,000,000 and is converted into dollars at the same 5.4000 fixing that created it, which is why the payment is $370,370 and not the $384,615 that BRL 2,000,000 would have been worth at the original 5.2000 rate.

Key terms

Fixing rate — The official reference rate published on the fixing date, against which the contract rate is compared.
Fixing source — The named publisher of that rate, such as a central bank or an industry benchmark administrator.
Settlement currency — The convertible currency the net difference is paid in, most often US dollars.
Fixing date — The date the reference rate is observed, normally a day or two before the cash actually settles.
Restricted currency — The currency the contract references but never delivers, because capital controls block offshore settlement.
Basis risk — The residual exposure left when the fixing differs from the rate the hedger transacts at onshore.

Every key term, A to Z

In practice

Exporters and importers dealing with Brazil, India, Korea or Taiwan use NDFs to hedge invoices they cannot settle offshore, and emerging-market bond funds use them to strip currency risk out of local-currency debt they already hold. Macro funds are heavy users too, because for an offshore account an NDF is often the only practical way to take a position in a currency it is not allowed to own.