In finance, a non-deliverable forward (NDF) is an outright forward or futures contract in which counterparties settle the difference between the contracted NDF price or rate and the prevailing spot price or rate on an agreed notional amount.
[1] NDFs are prevalent in some countries where forward FX trading has been banned by the government (usually as a means to prevent exchange rate volatility).
The most commonly traded NDF tenors are IMM dates, but banks also offer odd-dated NDFs.
On the contracted settlement date, the profit or loss is adjusted between the two counterparties based on the difference between the contracted NDF rate and the prevailing spot FX rates on an agreed notional amount.
Nevertheless, either counterparty can cancel an existing contract by entering into another offsetting deal at the prevailing market rate.
So, at the same time as disbursing the dollar sum to the borrower, the lender enters into a non-deliverable forward agreement with a counterparty (for example, on the Chicago market) that matches the cash flows from the foreign currency repayments.
Although this is theoretically identical to a second currency loan (with settlement in dollars), the borrower may face basis risk: the possibility that a difference arises between the swap market's exchange rate and the exchange rate on the home market.
NDF counterparties, however, may prefer to work with a limited range of entities (such as those with a minimum credit rating).