What is NDF?
A cash-settled, short-term forward contract on a thinly traded or non-convertible foreign currency, where the profit or loss at the time of the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of settlement, for an agreed upon notional amount of funds.
All NDF’s have a fixing date and a settlement date. The fixing date is the date at which the difference between the prevailing market exchange rate and the agreed upon exchange rate is calculated. The settlement date is the date by which the payment of the difference is due to the party receiving payment.
NDF’s are commonly quoted for time periods of one month up to one year, and are normally quoted and settled in U.S. dollars. They have become a popular instrument for corporations seeking to hedge exposure to foreign currencies that are not internationally traded.
Examples of currencies which NDF can be done
Currencies which are not internationally traded and which do not possess forward market for non-domestic players like Philippine Peso (PHP), Indian Rupee(INR), Taiwan Dollars(TWD), Korean Won (KRW)and Chinese Renminbi(CNY).
An Example Of NDF
Assume on 9th June 200X, a Corporation sells PHP 55 mio. NDF to ARAB BANK 3 months forward for value 10th September 200X, at the NDF rate of USD/PHP 55.00. Rate fixing date 9th September 200X.
By transacting the above, the company has lock-in the 3-month forward PHP selling rate at USD/PHP 55.00, which is equivalent to company buying USD 1 mio. (PHP 55 mio).
On 9th September 200X, the fixing date, at 11.00 am Manila time, the NDF rate will be compared with the prevailing USD/PHP fixing rate. There are 3 possible scenarios:-
The prevailing USD/PHP rate is equal to the NDF rate:
Assuming that the prevailing USD/PHP is exactly 55.00 on 9th September.200X.
In this instance there is no difference between the NDF and prevailing rates, hence no payment is made by either parties and the NDF expires.
The prevailing USD/PHP rate is higher than the NDF rate:
Assuming that the prevailing USD/PHP is 60.00 on 9th September.200X. In this instance, the PHP has weakened and there is a difference of 5 PHP. Hence Arab Bank will pay the difference to the Corporation on the settlement .
Date (10th September.200X).
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On 10/Sep, Bank pays USD 83,333.33 to Company and the NDF is settled. The prevailing USD/PHP rate is lower than the NDF rate:
Assuming that the prevailing USD/PHP is 50.00 on 9th September 200X. In this instance PHP has strengthened and there is a difference of 5 PHP. Hence the Corporation will pay the difference to Arab Bank on the settlement date (10th September).
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On 10/Sep., Company pays USD 100,000 to Bank and the NDF is settled.
NDF prices are quoted for up to one year. However, because of changing market liquidity, its advisable to contact ARAB BANK Treasury.
The above information is not a recommendation or investment advise and appears for information purposes only. While information given believed to be reliable, ARAB BANK guarantee its accuracy or completeness, and accept no responsibility whatsoever (including any loss suffered by any company or individuals) resulting from trading on its basis. No rights can be gained from this publication. There are risk involved in this product