Understanding Non-Deliverable Forwards (NDFs): A Complete Guide

What is a Non-Deliverable Forward?

A Non-Deliverable Forward (NDF) is a cash-settled, short-term forward contract on a foreign currency that is restricted or illiquid in the international market. Instead of exchanging the notional amounts at maturity, the two parties settle the difference between the agreed forward rate and the prevailing spot rate in a freely convertible currency, usually the U.S. dollar.

How Does an NDF Work?

At the trade date, counterparties agree on the notional amount, forward rate, fixing date, and settlement date. On the fixing date, an official reference rate—often published by the central bank—is compared with the forward rate. The profit or loss, known as the settlement amount, is calculated by multiplying the rate difference by the notional amount. Payment is then made on the settlement date, eliminating the need to move restricted currency across borders.

Benefits and Use Cases

NDFs allow corporations, fund managers, and speculators to hedge or gain exposure to currencies such as the Chinese yuan, Indian rupee, or Brazilian real without violating local capital controls. Because the contract is off-balance-sheet and requires no upfront premium, it delivers efficient risk management. Banks also use NDFs to offset positional imbalances created by customer flows in emerging-market currencies.

Risks to Consider

Like all derivative instruments, NDFs carry counterparty credit risk. Market participants are also exposed to liquidity risk, as bid-ask spreads can widen sharply during periods of volatility. Regulatory changes in the reference country may alter fixing methodologies, creating basis risk between onshore and offshore rates.

Popular NDF Currencies

The most actively traded NDF pairs include USD/CNY, USD/INR, USD/KRW, USD/BRL, and USD/CLP. Tenors typically range from one month to one year, though the one- and three-month contracts dominate daily turnover.

Key Takeaways

Non-Deliverable Forwards provide a practical solution for hedging and speculating on currencies under capital controls. Understanding contract terms, counterparty strength, and market liquidity is essential for reaping the strategic benefits while mitigating inherent risks and avoiding unexpected settlement surprises.