Non-Deliverable Swap - NDS

AAA

DEFINITION of 'Non-Deliverable Swap - NDS'

A currency swap between major and minor currencies that is restricted or not convertible. A non-deliverable swap (NDS) is so-called because there is no delivery of the two currencies involved in the swap, unlike a typical currency swap where there is physical exchange of currency flows. Periodic settlement of an NDS is done on a cash basis, generally in U.S. dollars. The settlement value is based on the difference between the exchange rate specified in the swap contract and the spot rate, with one party paying the other the difference. A non-deliverable swap can be viewed as a series of non-deliverable forwards bundled together.

INVESTOPEDIA EXPLAINS 'Non-Deliverable Swap - NDS'

Multinational corporations use NDSs to mitigate the risk that they may not be allowed to repatriate profits because of currency controls. They also use NDSs to hedge the risk of abrupt devaluation or depreciation in a restricted currency with little liquidity, and to avoid the prohibitive cost of exchanging currencies in the local market. Financial institutions in nations with exchange restrictions use NDSs to hedge their foreign currency loan exposure.
 
The key variables in an NDS are:

  • the notional amounts (that is, the amounts of the transaction)
  • the two currencies involved (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 sourced from reputable and independent market sources.

For example, consider a financial institution – let’s call it LendEx – based in Argentina, that has taken a five-year US$10 million loan from a U.S. lender at a fixed interest rate of 4% per annum payable semi-annually. LendEx has converted the U.S. dollar into Argentine pesos at the current exchange rate of 5.4, for lending to local businesses. However, it is concerned about the future depreciation of the peso, which will make it more expensive to make the interest payments and principal repayment in U.S. dollars. It therefore enters into a currency swap with an overseas counterparty on the following terms:

  • Notional amounts – US$400,000 for interest payments and US$10 million for the principal repayment.
  • Currencies involved – Argentine peso and US$.
  • Settlement dates – 10 in all, the first one coinciding with the first interest payment and the 10th and final one coinciding with the final interest payment plus principal repayment.
  • Contract rates for the swap – For the sake 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 – Two days before the settlement date, sourced at 12 noon EST from Reuters.

Here’s how the NDS works. On the first fixing date – which is two days before the first interest payment / settlement date – assume 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 have 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. (6.0 - 5.7) x 400,000 = 120,000 / 6 = $20,000].
 
On the second fixing date, assume the spot exchange rate is 6.5 to the U.S. dollar. In this case, because the spot exchange rate is worse 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 process continues until the final repayment date. A key point to note here is that because this is a non-deliverable swap, settlements between the counterparties are made in U.S. dollars, and not in Argentine pesos.

RELATED TERMS
  1. Dual Currency Swap

    A currency swap used to hedge the risk associated with the issuance ...
  2. Currency Swap

    A swap that involves the exchange of principal and interest in ...
  3. Hedge

    Making an investment to reduce the risk of adverse price movements ...
  4. Maturity Date

    The date on which the principal amount of a note, draft, acceptance ...
  5. Non-Deliverable Forward - NDF

    A cash-settled, short-term forward contract on a thinly traded ...
  6. Swap

    Traditionally, the exchange of one security for another to change ...
Related Articles
  1. thinkstock|istock
    Options & Futures

    A Primer On The Forex Market

    Moving from equities to currencies requires you to adjust how you interpret quotes, margin, spreads and rollovers.
  2. Fundamental Analysis

    Derivatives 101

    Learn how to use this type of investment as an alternative way to participate in the market.
  3. Bonds & Fixed Income

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  4. Options & Futures

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  5. Bonds & Fixed Income

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  6. Forex Education

    Hedging With Currency Swaps

    The wrong currency movement can crush positive portfolio returns. Find out how to hedge against it.
  7. Active Trading

    An In-Depth Look At The Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  8. Forex Education

    Currency Swap Basics

    Find out what makes currency swaps unique and slightly more complicated than other types of swaps.
  9. Forex Education

    The Forex Market: Who Trades Currency And Why

    The forex market has a lot of unique attributes that may come as a surprise for new traders.
  10. Options & Futures

    Getting Started In Forex

    Before entering this market, you should define what you need from your broker and from your strategy.

You May Also Like

Hot Definitions
  1. Christmas Island Dollar

    The former currency of Christmas Island, an Australian island in the Indian Ocean that was discovered on December 25, 1643. ...
  2. Santa Claus Rally

    A surge in the price of stocks that often occurs in the week between Christmas and New Year's Day. There are numerous explanations ...
  3. Commodity

    1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often ...
  4. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's balance sheet as a liability, until the services have been ...
  5. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  6. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
Trading Center