Describe a non-deliverable forward and provide a business scenario for its use.

Expert Solution

A non-deliverable forward is a cash-settled, and usually short-term, forward contract. The notional amount is never exchanged, hence the name non-deliverable. Two parties agree to take opposite sides of a transaction for a set amount of money - at a contracted rate, in the case of a currency NDF. This means that counter-parties 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.

They are most frequently quoted and settled in U.S. dollars

The largest NDF markets are in the Chinese yuan, South Korean won, new Taiwan dollar, and Brazilian real.

Business Scenario Example

If one party agrees to buy Chinese yuan (sell dollars), and the other agrees to buy U.S. dollars (sell yuan), then there is potential for a non-deliverable forward between the two parties. They agree to a rate of 10.4 on $1 million U.S. dollars. The fixing date will be in one month, with settlement due shortly after.
If in one month the rate is 10.3, the yuan has increased in value relative to the U.S. dollar. The party who bought the yuan is owed money. If the rate increased to 10.5, the yuan has decreased in value (U.S. dollar increase), so the party who bought U.S. dollars is gaining.

jeff jeffy answered 6 months ago

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