An NDF is a name given to a short-term, cash-settled currency forward between two counterparties. On the contracted settlement date, the adjustment of profit or loss takes place between the two counterparties and that adjustment is based on the difference between the contracted NDF rate and the prevailing spot FX rates on an agreed notional amount.

An NDF include the following features:

• The notional amount: This is the name given to the “face value” of the NDF, that is agreed between the two counterparties. You should note down here that there is never any intention to exchange the notional amounts in the two currencies.
• The fixing date: The fixing date is that day and time whereby the comparison between the NDF rate and the prevailing spot rate is made.
• The settlement (or delivery) date: The settlement (or delivery) date is referred to as the day when the difference is paid or received. It depending on the currencies dealt, one or two good business days before the settlement date is the fixing date.

• The contracted NDF rate: The contracted NDF rate is the rate that has been agreed on the transaction date between the two counterparties, and it is essentially the outright forward rate of the currencies dealt.

• The prevailing spot rate: Usually the central bank provides the fixing spot rate on the fixing date, and it is commonly calculated by calling a number of dealers in the market for a quote at a specified time of day, and then taking the average. When a trade is initiated then the exact method of determining the fixing rate will be agreed, but most NDF markets have got their own conventions.

Due to the reason that an NDF is a cash-settled instrument, the notional amount is never exchanged. The difference between the NDF rate and the prevailing spot market rate that is exchanged on the settlement date is the only exchange of cash flows.

Consequently, NDFs are “non-cash” products, which are off-the-balance-sheet and as there is no  movement in principal sums, so it possess much lower counter-party risks. NDFs are committed short-term instruments; both the counterparties of NDFs are committed and are they are obliged to honor the deal. Nevertheless, an existing contract  can be cancelled by either counterparty by entering into another offsetting deal at the prevailing market rate.

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