Non-deliverable forwards are over-the-counter transactions settled not by delivery but by exchange of the difference between the contracted rate and some reference rate such as the one fixed by the Reserve Bank of India.
WHY IS AN NDF MARKET NEEDED?
The need for an NDF market arose because there were countries where forwards trading in currencies is not allowed or is allowed with a lot of restrictions that increases the cost of hedging for corporates. Also, such a market was felt necessary for economies with partially convertible currencies.
WHERE DO THESE TRADES HAPPEN? WHICH ARE THE PROMINENT CURRENCIES?
NDF trading happens in cities such as Singapore, London, New York and Hong Kong. Brazilian Real, Chinese Renminbi, Taiwanese dollar, South Korean won and Indian rupee are among the prominent currencies.
WHO TRADES IN NDFS?
Hedge funds and foreign institutional investors, which are allowed to hedge only their actual exposure and not potential exposure; global corporations that do their invoicing in Indian rupee but are not allowed to hedge their exposures; and speculators betting on the direction of the rupee without any exposure.
HOW DOES AN NDF TRANSACTION OCCUR?
An Indian corporate that is registered in, say, Singapore under a different name and has nothing to do with its Indian counterpart legally, may buy dollars from the spot market in India (Mumbai) at, say, 53.60 per dollar (the reference rate) and sell it in the NDF market in Singapore at 54 per dollar (the contract rate), making an arbitrage of 40 paise. The transaction is carried out by a foreign bank that has branches in both Mumbai and Singapore.
WILL NDF MARKET MOVEMENTS AFFECT SPOT RATES?
Yes, they do to some extent and mainly through international banks and companies that take offsetting positions in the domestic and overseas books. WILL RBI CURBS ON OVERNIGHT POSITIONS AFFECT NDFS? Yes, it will squeeze international banks that were profiting from the wild currency movements through their positions in the NDF market while pressuring the spot market due to temporary factors. RBI studies had shown weak linkage between the domestic and NDF markets when the currency movements are in a narrow range.
WHAT ARE FIXING AND SETTLEMENT DATES?
The fixing date is the date on which the difference between the prevailing market exchange rate and the agreed upon exchange rate or the reference rate is calculated. The settlement date is the date by which the payment of the difference is due
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