Non-Deliverable Swap (NDS) definition
Non-deliverable Swap (NDS) is a form of currency exchange between major and restricted/non-convertible minor currencies. This means that the two currencies involved in the exchange are not actually offered, unlike a typical cash exchange where cash flows are physically exchanged. Instead, NDSs are usually cashed in US dollars. The estimated cost is based on the difference between the exchange rate established in the currency contract and the spot rate at which one party pays the difference to the other. A non-deliverable swap can be thought of as a series of non-deliverable forwards joined together.
A non-deliverable swap (NDS) is a type of exchange that pays and settles in US dollar equivalents instead of the two currencies being exchanged. Therefore, the exchange is termed non-convertible (restricted) because the underlying currency is not physically supplied. NDSs are frequently utilized when the underlying currency is difficult to obtain, illiquid or volatile, such as developing countries’ currencies or those with restrictions such as Cuba or North Korea.
Non-Deliverable Swaps (NDS) Explained
A non-deliverable swap (NDS) is a swap of different currencies; a major and minor currency that is restricted. Cash flow on most exchanges physically changes when a swap occurs contrary to what occurs in the case of NDS. Non-deliverable swaps don’t physically alter cash flows because the currencies are not transferred. The two currencies involved in the swap don’t get delivered and this is why they are termed non-deliverable swaps. They aren’t available on the exchange. International companies use NDS to minimize the risk of profit margins in case they’re prevented from transferring profits home through currency controls.
They also use NDSs to hedge the risk of excessive depreciation or amortization in limited currencies with little liquidity and to avoid excessive local currency costs. Financial institutions in currency-restricted countries use NDSs to hedge foreign currency loans. There are ways to pay NDS regularly. This is usually done in cash using the US dollars. To settle between the two currencies involved, the value is based on a spot exchange rate and the exchange rate specified in the currency contract. To obtain an NDS settlement, one of the parties involved must pay the other party the difference in tax rates between when the contract was signed and when the agreement was reached.
The most important variables in NDS are:
- Transaction amount or notional amount
- Two currencies involved (the non-deliverable currency and the currency used for settlement)
- Settlement date
- Contract exchange rate
- Date and the fixing rates – specific dates for which spots rates would be obtained from independent reputable sources.
Non-deliverable swaps (NDS) include limited major and minor currency exchanges. NDS differs from non-deliverable forward exchange (NDF) in two main ways. NDFs usually do not involve the main currency and the difference between the contract rate and the spot rate is an agreed-upon nominal amount. The US dollar is the most widely used payment mechanism for cheap swaps.
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