How It Works
A Non-Deliverable Forward (NDF) FX transaction is an FX Forward hedging mechanism where the physical exchange of currency at expiry is replaced by settlement between counterparties of the net profit/loss on the contract, calculated using the prevailing Spot Fixing Rate two days prior to settlement. The net settlement will occur in a predetermined convertible currency, typically USD.
An NDF is used when the client needs to hedge against a currency that does not have a deliverable market offshore, including Taiwan Dollar (TWD), Korean Won (KRW), Chinese Yuan (CNY), Brazilian Real (BRL), and Argentinean Pesos (ARS).
No exchange of principal. No upfront fee.
XYZ Company imports telecommunication equipment from a Brazilian supplier at a cost of BRL 3 million. XYZ Co. is invoiced and payment is due in 180 days (t+180). The supplier wishes to be paid in USD in an amount equivalent to BRL 3 MM. Thus XYZ Co., and not the supplier, is exposed to exchange rate fluctuations.
XYZ Co: Buys BRL / Sells USD
Amount: BRL 3.0 MM
Forward NDF Rate: 0.7690
NDF Hedge is In-the-Money
Spot Fixing Rate: 0.8000
At maturity XYZ Co. has the obligation to buy BRL 3.0 MM from Square 1 Bank at the rate of 0.7690 compared to the spot fixing rate of 0.8000. However, since BRL is a non-convertible currency, the net amount will be settled in USD.
To settle the NDF, Square 1 Bank will make a payment of USD 93,000 to XYZ Co. on t+180. The amount is calculated as follows from the perspective of XYZ Co:
(BRL 3.0 MM * 0.8000) - (BRL 3.0 MM * 0.7690) = USD 93,000
XYZ Co. benefits from the hedge despite the strengthening of BRL and can budget that the net cost of the equipment will be, in dollar terms, USD 2.307 MM. XYZ Co. will then have Square 1 Bank wire to the Brazilian supplier USD 2.4 MM and XYZ Co. will also receive USD 93,000 from Square 1 Bank. The net of the payments equals the budgeted amount of USD 2.307 MM. The supplier will then convert the USD to BRL with its own bank.
NDF Hedge is Out-of-the-Money
Fixing Rate: 0.7410
At maturity XYZ Co. has the obligation to buy BRL 3.0 MM from Square 1 Bank at the rate of 0.7690 compared to the fixing rate of 0.741. However, since BRL is a non-convertible currency, the net amount will be settled in USD.
To settle the NDF, XYZ Co. will make a payment of USD 84,000 to Square 1 Bank on t+180. The amount is calculated as follows from the perspective of XYZ Co:
(BRL 3.0 MM * 0.741) - (BRL 3.0 MM * 0.7690) = - USD 84,000
XYZ Co. will have Square 1 Bank wire USD 2.223 MM to the Brazilian supplier and will pay USD 84,000 to Square 1 Bank. The sum of the payments equals the budgeted amount of USD 2.307 MM. The supplier will then convert the USD to BRL with its own bank.
- Easily implemented for both future foreign payables and receivables.
- Eliminates adverse fluctuations to currency exposure and locks in an exchange rate as of trade date.
- Easily implemented as a series of forward NDF transactions for recurring FX hedging needs such as payroll.
- NDFs are moderately liquid and transparent foreign exchange hedging tools.
- Allows a client to keep allocated cash in its main operating currency until the time of settlement.
- Provides fixed hedges for foreign line items impacting budgeted financial statements and increases accuracy to pro forma financial statement building.
- Minimal sovereign/convertibility risk. Minimal dependence on local markets, except for fixing.
To learn more, please contact Stasia Harris , SVP, Treasury Management.