Non-Deliverable Forward (NDF) Transactions

Non-Deliverable Forward (NDF) Transactions

A Non-Deliverable Forward (NDF) is a type of foreign exchange forward contract in which, unlike a standard deliverable forward, the two parties do not exchange the underlying principal amounts at maturity. Instead, only the net difference between the agreed-upon forward exchange rate and the spot exchange rate at maturity—known as the fixing rate—is settled in a designated currency.

 

 

Because only the difference is settled, NDFs involve lower settlement risk than traditional forward contracts and require a smaller initial capital outlay. This creates a high leverage effect, making NDFs widely used not only as a tool for hedging foreign exchange risk but also for speculative trading aimed at capturing exchange rate gains.

 

In most NDF contracts, the settlement currency is the U.S. dollar. This allows non-residents to trade forward contracts on non-convertible or less internationalized currencies—such as the Korean won—without the need to hold or exchange the local currency itself.

 

The fixing rate is determined according to the agreement between the counterparties. In the case of a KRW–USD NDF, it is typically set as the official spot exchange rate announced on the day prior to the maturity date.

 

Standard settlement tenors include 1 month, 2 months, 3 months, 6 months, 9 months, 1 year, 2 years, 3 years, 4 years, and 5 years.

 

For example, suppose Bank A enters into a three-month NDF contract with Bank B to buy USD 1 million at an exchange rate of KRW 1,300 per U.S. dollar. If, on the day before maturity, the spot exchange rate (fixing rate) is KRW 1,400 per dollar, Bank A earns a profit of KRW 100 per dollar, or a total of KRW 100 million. Bank B then settles this amount by paying the equivalent in U.S. dollars—USD 71,428.57—to Bank A on the maturity date.

 

 

Related term: Forward Exchange Transactions