“Non-deliverable forwards (NDFs) are financial instruments used in foreign exchange markets to hedge or speculate on the future value of a currency. They are a type of forward contract that is settled in cash, rather than by physical delivery of the underlying asset.
NDFs are typically used in countries where the currency is not freely tradable or where the currency is subject to capital controls. In these situations, it may be difficult or impossible to trade the currency in the spot market or to deliver the currency at a future date. Instead, counterparties agree to settle the contract in a more freely traded currency, such as the US dollar.
In an NDF, the two parties agree to exchange a fixed amount of one currency for another currency at a future date, typically ranging from one month to one year. The exchange rate is agreed upon at the time the contract is entered into, and the settlement amount is determined by the difference between the agreed-upon exchange rate and the prevailing spot rate at the time of settlement.
NDFs can be used for hedging or speculation purposes. Companies may use NDFs to hedge against currency risk when doing business in countries with non-convertible currencies or to lock in a future exchange rate for a transaction. Investors may use NDFs to speculate on the future direction of a currency or to profit from interest rate differentials between two currencies.
Overall, NDFs are a useful financial instrument for managing currency risk in countries with restrictions on the free flow of currency. However, they also carry risks and require careful consideration and management of counterparty risk and market volatility.”
Sourced from Chat GPT, assessed by Sean Lee