Non-Deliverable Swap (NDS)

What Is a Non-Deliverable Swap (NDS)?

A non-deliverable swap (NDS) is a variation on a currency swap among major and minor currencies that is restricted or not convertible. This means that there is no genuine delivery of the two currencies engaged with the swap, not at all like a commonplace currency swap where there is physical exchange of currency flows. All things being equal, periodic settlement of a NDS is finished on a cash basis, generally in U.S. dollars.

The settlement value depends on the difference between the exchange rate determined in the swap contract and the spot rate, with one party paying the other the difference. A non-deliverable swap can be seen as a series of non-deliverable forwards packaged together.

Figuring out Non-Deliverable Swaps (NDS)

Non-deliverable swaps are utilized by global partnerships to relieve the risk that they may not be permitted to localize profits as a result of currency controls. They likewise use NDSs to hedge the risk of sudden devaluation or depreciation in a restricted currency with little liquidity, and to keep away from the restrictive cost of trading currencies in the neighborhood market. Financial institutions in nations with exchange limitations use NDSs to hedge their foreign currency loan exposure.

The key factors in a NDS are:

the notional amounts (that is, the amounts of the transaction)
the two currencies included (the non-deliverable currency and the settlement currency)
the settlement dates
the contract rates for the swap, and
the fixing rates and dates - the specific dates on which the spot rates will be obtained from respectable and independent market sources.

NDS Example

Think about a financial institution - we should call it LendEx - situated in Argentina, that has required a five-year US$10 million loan from a U.S. lender at a fixed interest rate of 4% per annum payable semi-yearly. LendEx has changed over the U.S. dollar into Argentine pesos at the current exchange rate of 5.4, for lending to nearby organizations. Be that as it may, it is worried about the future depreciation of the peso, which will make it more costly to make the interest payments and principal repayment in U.S. dollars. It subsequently goes into a currency swap with an overseas counterparty based on the accompanying conditions:

Notional amounts (N) - US$400,000 for interest payments and US$10 million for the principal repayment.
Currencies involved - Argentine peso and U.S. dollar.
Settlement dates - 10 altogether, the first agreeing with the primary interest payment and the 10th and last one corresponding with the last interest payment plus principal repayment.
Contract rates for the swap (F) - For the purpose of simplicity, say a contract rate of 6 (pesos per dollar) for the interest payments and 7 for the principal repayment.
Fixing rates and dates (S) - Two days before the settlement date, obtained at 12 noon EST from Reuters.

The methodology for deciding the NDS follows the accompanying equation:

Profit = (NS - NF)/S = N (1 - F/S)

This is the way the NDS resolves in this model. On the principal fixing date - which is two days before the primary interest payment/settlement date - expect the spot exchange rate is 5.7 pesos to the U.S. dollar. Since LendEx has contracted to buy dollars at a rate of 6, it would need to pay the difference between this contract rate and the spot rate times the notional interest amount to the counterparty. This net settlement amount would be in U.S. dollars and works out to - $20,000 [i.e. (5.7 - 6.0) x 400,000 = - 120,000/6 = - $20,000].

On the subsequent fixing date, expect the spot exchange rate is 6.5 to the U.S. dollar. In this case, on the grounds that the spot exchange rate is more terrible than the contracted rate, LendEx will receive a net payment of $33,333 [calculated as (6.5 - 6.0) x 400,000 = 200,000/6 = $33,333].

This interaction go on until the last repayment date. A key point to note here is that since this is a non-deliverable swap, settlements between the counterparties are made in U.S. dollars, and not in Argentine pesos.

Features

NDS are typically utilized when the underlying currencies are hard to get, are illiquid, or are unpredictable - for example, for non-industrial nation currencies or restricted currencies like Cuba or North Korea.
A non-deliverable swap (NDS) is a type of currency swap that is paid and settled in U.S. dollar equivalents as opposed to the two currencies engaged with the actual swap.
Thus, the swap is viewed as non-convertible (restricted) since there is no physical delivery of the underlying currencies.