Non-Deliverable Forward Foreign Exchange Contracts At A Glance

Wed Feb 27 15:24:38 EST 2013
Capabilities and Services

Exposure to foreign exchange rate risk is often hedged with forward foreign exchange (“FX”) contracts, which fix an exchange rate now for settlement at a future date. The parties to an FX forward agree to buy or sell a currency at a specified exchange rate, at a specified quantity and on a specified future date. On the specified future date, the two parties exchange the currency amounts to settle their claims under the contract.

Some countries’ monetary authorities impose restrictions on their currency’s convertibility in order to regulate the currency’s inflow and outflow. As a consequence, offshore parties can face difficulty hedging their exposure with forward contracts as such transactions might not be allowed under the currency restrictions. As a result, markets for non-deliverable forwards, which do not require the exchange of the
non-convertible currency, have developed.

A non-deliverable forward foreign exchange contract (“NDF”) is similar to a regular forward FX contract but does not require physical delivery of the designated currencies at maturity. Instead, the NDF specifies an exchange rate (“contracted forward exchange rate” or simply “forward rate”) against a convertible currency, typically...

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