Classification of Forward Contracts – Delivery vs Non-Delivery

Does the Farmer actually bring the Wheat? Or just send a Cheque?

1. Delivery Based Forwards (Create Physical Movement)

• Measurement: 99% of Commodity Forwards.
• Action: On expiry, the Seller delivers the asset (Wheat/Gold) and Buyer pays full cash.
• Usage: Used by factories who actually need the raw material.

2. Non-Deliverable Forwards (NDF) / Cash Settled

• Measurement: Common in Financials (Currencies).
• Action: On expiry, no asset is exchanged. Only the difference (Profit/Loss) is paid.
• Why? Sometimes trading the asset is restricted (e.g., Rupee trading in Singapore).

3. Usage of NDFs

NDFs allow foreign investors to hedge currency risk even if they cannot access the local onshore market.

• Example: A US Investor wants to hedge Rupee risk but doesn't want to register in India. He buys an INR NDF in Singapore/Dubai.

4. Exam Notes: Writing the Answer

Question: "What is an NDF (Non-Deliverable Forward)?" (5 Marks)

Answering Strategy:

1. Define: "Cash-settled forward contract...".
2. Settlement: Explain that principal is never exchanged, only the difference.
3. Location: Usually traded offshore (outside the home country of the currency).

Summary

• Physical: Goods move.
• Cash/NDF: Money moves.

Quiz Time! 🎯

Loading quiz…