EECS 3101 Lecture Notes - Lecture 31: Chilean Peso, Reference Rate

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EECS 3101 Lecture 31 Notes
Introduction
Non-Deliverable Forward Contracts
The transactions do not expose Soho to exchange rate movements because it has locked
in the rate at which the pesos will be converted back to dollars.
However, if the one-year forward rate exhibits a discount then Soho will receive fewer
dollars later than it invested in the subsidiary today.
Even so, the firm may still be willing to engage in the swap transaction so that it can be
certain about how many dollars it will receive in one year.
A non-deliverable forward contract (NDF) is often used for currencies in emerging
markets.
Like a regular forward contract, an NDF is an agreement regarding a position in a
specified amount of a specified currency, a specified exchange rate, and a specified
future settlement date.
However, an NDF does not result in an actual exchange of the currencies at the future
date
That is, there is no delivery.
Instead, one party to the agreement makes a payment to the other party based on the
exchange rate at the future date.
EXAMPLE
Jackson, Inc., an MNC based in Wyoming, determines as of April 1 that it will need 100
million Chilean pesos to purchase supplies on July 1.
It can negotiate an NDF with a local bank.
The NDF will specify the currency (Chilean peso)
The settlement date (90 days from now); and a reference rate, which identifies the type
of exchange rate that will be marked to market at the settlement
Specifically, the NDF will contain the following information.
Buy 100 million Chilean pesos.
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Document Summary

The transactions do not expose soho to exchange rate movements because it has locked in the rate at which the pesos will be converted back to dollars. The settlement date (90 days from now); and a reference rate, which identifies the type of exchange rate that will be marked to market at the settlement. Specifically, the ndf will contain the following information. Transactions do not expose soho to exchange rate movements because it has locked in the rate at which the pesos will be converted back to dollars. However, if the one-year forward rate exhibits a discount then soho will receive fewer dollars later than it invested in the subsidiary today. Even so, the firm may still be willing to engage in the swap transaction so that it can be certain about how many dollars it will receive in one year. A non-deliverable forward contract (ndf) is often used for currencies in emerging markets.

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