Non-Deliverable Forward (NDF)
Candlefocus EditorNDFs are commonly used for hedging against exchange rate risks for exporters, importers, and other organizations conducting business in countries with volatile currencies. By writing an NDF contract, an organization can lock-in an expected rate of exchange and reduce their risk of fluctuations. These derivatives are useful for those operating in countries with closed currency markets and limited access to hedging tools.
The US dollar is typically used as the base currency in NDF contracts, with the rate being based on the difference between the spot rate at the time of execution and the forward rate. The largest segment of NDF trading is done using the US dollar and takes place mostly in London, with active markets also in Singapore and New York. The largest NDF markets are typically in the Chinese yuan, Indian rupee, South Korean won, New Taiwan dollar, and Brazilian real.
NDF contracts are generally not subject to standard regulations, such as margin requirements or settlement procedures. This lack of regulation means that investors should proceed with caution when using NDFs and conduct due diligence to ensure they understand all of the terms and conditions associated with the contract. Furthermore, as the NDF market is largely unregulated and still relatively immature, there is a risk of price manipulation, and it is wise to diversify across multiple dealers.
In conclusion, the non-deliverable forward (NDF) is a useful financial instrument for those organizations conducting business in countries with closed currency markets and limited access to hedging products. The largest NDF markets are typically in the Chinese yuan, Indian rupee, South Korean won, New Taiwan dollar, and Brazilian real. Although NDF contracts are not subject to standard regulations, investors should seek to understand all the terms associated with the agreement and diversify across multiple dealers to minimize the risk of price manipulation.