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 The RMB NDF (Non-Deliverable Forward) is a kind of financial derivative instrument that helps the foreign companies in china or the companies with transactions overseas to hedge their foreign exchange risk. As the foreign exchange regime of china has been undergoing a dramatic change recently, the importance of a variety of forex derivatives looms large. The RMB NDF is drawn on in the following ways (bear in mind that RMB in this case is treated as asset while USD as money): for instance, the accounts receivable of a foreign company may be credited in 3 months and the company is going to sell the RMB to be received for USD at the request from its parent company in US. In order to circumvent the risks involved in 3 months, the company may well sell the RMB NDF at 7.8550 to the bank which operates offshore NDF business. 3 month later, if the RMB depreciates to 7.8600, the company can get the principle times (1/7.8550-1/7.8600) USD from the bank to offset the loss incurred in the spot market, where it sells the RMB at 7.8600 and get the principle times 1/7.8600 USD in return. So the cash inflow of the company at the end of the 3-month period consists of two elements, one from the forward, the other from the spot, adding up to the total, namely, the principle times 1/7.8550. Note that 7.8550 is the rate initially intended. The difference between NDF and DF lies in the fact that NDF is settled by cash and DF is settled by delivering the underlying assets. The bank itself evades the risk by trying to maintain zero-open-position and earns its profit by buying forward RMB at lower value of 7.8550 and selling at higher value of 7.8450. The spread is meant to be huge as such due to the illiquidity in the RMB NDF market. In order to maintain zero-open-position, the bank will be forced to move the bid or ask price. Therefore the effective gain is always less than the spread. If the spread is not sufficiently large, the bank will be exposed to risk. However, the bank sometimes intends to take the position when the forward price of RMB is too high or too low. For example, when the speculators push the price too high, the bank may sell the NDF at the asked price under the request of the buyer without offsetting its open position immediately by gearing up the bid price until the same amount of the forward is bought, because the bank is expecting the price to fall sooner or later so that it may earn a speculative profit from its clients in the forward market. |
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