Non-deliverable forward
Also written NDF · Non-deliverable forward (NDF) · Non-deliverable derivative contract · NDDC · Non-deliverable forward contract
A cash-settled, usually short-term currency forward in which the notional amount is never exchanged — only the difference between the contracted rate and the reference rate changes hands.
In plain language
An ordinary foreign exchange forward ends in delivery. On the value date one party hands over dollars and the other hands over rupees.
A non-deliverable forward does not. The two sides agree a rate for a future date, and on that date they simply settle the difference in cash. The notional amount is never exchanged — which is where the name comes from.
The workbook's own definition is a single sentence: an NDF is a cash-settled, and usually short-term, currency forward contract, in which the notional amount is never exchanged.
Why would anyone want that? Because it lets someone take a rupee position without ever touching rupees. That is useful to a party outside India who cannot easily access the onshore market.
And it matters to India for a reason the workbook spells out. USDINR NDF volumes have grown, and they have begun to play an important role in both price discovery and driving volatility, particularly during periods of heightened uncertainty. The offshore market can move the onshore rate.
How it works
The definition (Chapter 1, footnote to section 1.3.8): a non-deliverable forward is a cash-settled, and usually short-term, currency forward contract; the notional amount is never exchanged, hence the name "non-deliverable".
Why the offshore market matters to Indian price discovery. Section 1.3.8 explains the gap that feeds it. Indian market hours for USD/INR spot, forward and options run 9.00 am to 5.00 pm, which overlaps Asian hours and the first half of the European day. But the market is shut during the US opening and the Asian opening, and any major event or data release in those hours is not priced in by residents. The result can be a gap-up or gap-down at the next opening. NDF volumes fill that gap, and the workbook records that they have begun to play an important role in price discovery and driving volatility.
The Indian rule set, from Chapter 2, section 2.6. Two sentences carry the regulation:
- While offering a foreign exchange derivative contract involving INR other than NDDCs to a user, and during the life of such contracts, Authorised Dealers shall ensure that the contract is for the purpose of hedging.
- All OTC foreign exchange derivatives contracts are settled through delivery except the Non-deliverable derivative contracts (NDDC).
So a non-deliverable contract is the one carve-out from both the hedging-purpose requirement and the delivery norm.
Who may offer them. The footnote to the same section: banks in India holding an Authorised Dealer Category-1 licence under FEMA, 1999 and operating International Financial Services Centre (IFSC) Banking Units (IBUs) are eligible to offer non-deliverable derivative contracts involving the Rupee, or otherwise, to persons not resident in India. Banks can undertake such transactions through their IBUs, through their branches in India, or through their foreign branches.
Read that carefully. The eligibility test is holding an AD Category-1 licence and operating an IBU. The permitted counterparty is a person not resident in India. The permitted route is any of three, including branches in India.
The global picture. Chapter 3's comparison of forwards and futures notes that OTC forward contracts are settled bilaterally, mainly through physical delivery, gross and without netting — but that globally, Non-Deliverable Forward contracts, that is settlement without delivery, are very popular. Exchange traded currency futures, by contrast, are cash settled in INR with multilateral netting.
No figure. The workbook gives no NDF turnover number, no tenor limit and no position cap. Its BIS turnover table separates spot, outright forwards, FX swaps, currency swaps and FX options, but does not break out NDFs.
A worked example
How a non-deliverable settlement works. Illustrative trade built on the workbook's own USDINR levels of 83.00 and 83.50 and its FBIL reference rate mechanism, which is what such a contract would fix against.
An offshore fund buys USD 1 million against INR one month forward at 83.50. At maturity the reference rate fixes at 84.10.
| Step | Deliverable forward | Non-deliverable forward |
|---|---|---|
| What the fund pays | Rs 8,35,00,000 | Nothing |
| What the fund receives | USD 1,000,000 | Nothing |
| Cash settlement | None | (84.10 - 83.50) x 1,000,000 = Rs 6,00,000 received |
| Rupees that actually moved | Rs 8.35 crore | Rs 6 lakh |
The economics of the position are the same. The plumbing is not. Only 0.7% of the notional ever changed hands.
Now the other direction. The reference rate fixes at 82.90 instead.
| Amount | |
|---|---|
| Contracted rate | 83.50 |
| Reference rate at maturity | 82.90 |
| Settlement | (82.90 - 83.50) x 1,000,000 = (Rs 6,00,000) paid by the fund |
Who may be on the other side. Suppose an Indian bank wants to take the trade.
| Bank | Eligible to offer this NDDC? |
|---|---|
| AD Category-1 bank operating an IFSC Banking Unit | Yes — and it may book it through the IBU, an Indian branch or a foreign branch |
| AD Category-1 bank with no IBU | No |
| The same bank, dealing with a resident Indian exporter | No — NDDCs involving the rupee are for persons not resident in India |
And the hedging test. Had the offshore fund instead asked for a plain deliverable INR forward, the bank would have had to satisfy itself that the contract was for the purpose of hedging — a requirement the workbook expressly does not apply to NDDCs.
Why NISM asks about it
The NDF is defined in a Chapter 1 footnote (section 1.3.8, Price discovery) and its regulatory treatment sits in Chapter 2, section 2.6 (Exchange-Traded Derivatives vs. OTC Derivatives) and its footnote; Chapter 3, section 3.5, notes that NDFs are globally popular in the forward-versus-futures comparison. The examinable points are the definition (cash settled, notional never exchanged), the NDDC carve-out from the delivery norm and the hedging-purpose requirement, the AD Category-1 plus IBU eligibility test, the non-resident counterparty, and the NDF market's role in price discovery and volatility for USDINR.
Common exam traps
- The notional is never exchanged. Only the difference settles. A question describing delivery of the principal is describing an ordinary forward.
- NDDCs are the exception to two rules at once: all other OTC FX derivative contracts are settled through delivery, and all other INR contracts must be for the purpose of hedging.
- Eligibility is AD Category-1 licence AND an IFSC Banking Unit. One without the other is not enough.
- The counterparty must be a person not resident in India for the rupee NDDCs described. It is not a retail product for residents.
- The bank may route it through its IBU, an Indian branch or a foreign branch — all three are permitted, so "only through the IBU" is wrong.
- NDF is OTC, not exchange traded. Exchange traded currency futures are also cash settled, but they are cash settled in INR with multilateral netting through a clearing corporation — a different arrangement entirely.
- The workbook credits NDFs with driving volatility as well as aiding price discovery. Do not answer that their effect is purely benign.
Check yourself
1.How does the workbook define a non-deliverable forward (NDF)?
- a)A physically settled forward in which only the notional amount is exchanged
- b)An exchange-traded forward settled in Indian rupees
- c)A cash-settled, usually short-term currency forward in which the notional amount is never exchanged
- d)A long-term forward that cannot be cancelled
Show the answer
Answer: (c) A cash-settled, usually short-term currency forward in which the notional amount is never exchanged
"A non-deliverable forward (NDF) is a cash-settled, and usually short-term, currency forward contract. The notional amount is never exchanged, hence the name 'non-deliverable.'"
Physical settlement contradicts the name.
NDFs are OTC forwards, not exchange-traded contracts.
"Long-term" is wrong — they are usually short-term.
Why they matter: "Non-Delivery Forward (NDF) volumes especially for USDINR pair have increased in the recent period, they have begun to play an important role in both price discovery and driving volatility, particularly during periods of heightened uncertainty."
Where this is taught
Free preparation for NISM Series IRelated terms
- FBIL reference rateThe daily USD/INR (and EUR, GBP, JPY vs INR) benchmark rate published by Financial Benchmarks India Pvt Ltd around 1.30 pm; it is the final settlement price of INR currency futures and options.
- Foreign exchange derivative contractUnder the FEMA regulations, a financial contract that derives its value from a change in the exchange rate of two currencies, at least one of which is not the rupee, and settles later than the spot date.
- Foreign exchange forwardAn OTC derivative involving the exchange of two currencies on a specified future date more than two business days away, at a rate agreed on the date of the contract.
- Forward contractA bilateral, over-the-counter agreement between two parties to buy or sell an asset on a fixed future date at a price agreed today — customised to suit them, and binding on both.
- Cash settlementSettling a derivative on expiry or exercise by exchanging the price difference, without delivering the underlying asset. SEBI mandates physical settlement for stock derivatives, not index derivatives.
- Over-the-counterA bilateral market where two parties negotiate a contract's terms directly, with no exchange or clearing house between them, unlike a standardised, centrally cleared exchange-traded market.
- Credit Default SwapA contract in which a protection buyer pays a regular premium to a protection seller, who agrees to pay any loss in value on a specified reference obligation if a credit event such as default occurs.