FX NDF

FX NDF(Non-Deliverable Forward)

1. Definition: There are usually FX forward but one is deliverable currency and another is non-deliverable. The non-deliverable currency can not be transferred or settled in USA.
2. Description: FX NDF = FX Forward + FX Spot (in the end of the maturity). There is a fixing , means the final FX rate is determined before the maturity. Usually fixing is determined 2 business days before the maturity date of the trade. Till the fixing is not determined, NDF mainly behave as FX forward.  FX NDF is different in final settlement- cashflow settlement.
3. Example: INR vs USD- Buying USD and selling INR currencies on 1Year completion
4. Trade Information:
   1. Trade Date -> 9/8/21
   1. Settlement/Maturity Date-> 9/8/22
   1. Currency Pair -> INR/USD
   1. Trade Price-> 80 INR for 1 USD
   1. Notional USD -> 1MM
   1. Notional INR -> 80MM
   1. Counterparty -> XYZ Bank
5. Link
6. Market Data
   1. INR vs USD FX spot rate
   1. INR vs USD FX Forward points curve.
   1. USD Discount factors.
7. Model Valuation and Risk

After 2 Months

Once we have market data how to use the market date calculate the NPV (Net Present Value) and Risks.

We need:

1. Spot Rate:INR vs USD FX spot rate.
2. Fwd Pts: Using Quant Tool, calibrate the INR vs USD FX Forward points. We can interpolate the calibrated the curve to determine what is the exact forward point to this 1YR trade.
3. USD DF :USD Discount factor calibration to get the DF for the 9/6/22.

In remaining 10 months:

FX spot rate -> 75

Fwd Point -> 10 ( maturing on 9/6/22)->This is the fixing date usually 2 business days before the maturity

USD DF -> .98 ( on 9/8/22)

New Price for the trade will be = FX spot rate + Fwd Point = 75 + 10 =85

Now convert 80MM INR into USD using 85 INR price => 941,176 USD

As per the contract we receive 1MM USD in exchange of 80MM INR

We can buy that particular day 80MM using only $941,176.

Hence the Future Value = +1,000,000 – 941,176 = 58,824

This is still future value which should be bring into present value

NPV = FV * DF

NPV = 58,824 * .98 = 57,647

After Sept 6^th, there is no INR exposure or risk. INR forward points are fixed and hence any change in INR will not be impacted on the trade valuation.

Risk:

There will be two types of risk:

1. Market risk -> FX spot risk, FX forward points risk( PV01 risk on Basis adjusted interest rate curve)  and USD interest rate risk
2. Credit Risk -> Counterparty Risk – After two months we made $58K but it is not realized yet. It means on the books but no generated in cash till the maturity date. What if the counterparty default, we lose this gain.
3. P&L Attribution:
   1. Current time Spot rate vs Previous spot rate difference.
   1. Current FX forward rate vs Previous FX forward rate difference. The basis adjusted interest rate curve is generated and hence PV01. Hence, the attribution is not directly on FX forward points but basis adjusted interest rate behind it.
   1. USD Discount factor change. Eventually the change in DF.
4. Accounting: The NPV of $57K will be debited to Assets and credited to P&L accounts. There will be increase in Assets and increase in equity via P&L

Collateral: As mentioned above there is counterparty risk. We would need the counterparty give some security to protect our interest as per the agreement