A synthetic derivative which is mainly used to replicate the net cash flows of a currency coupon swap or cross-currency swap when the two legs are a major currency and a minor currency. The minor currency is typically non-convertible, thinly-traded or subject to exchange restrictions. The settlement value at each payment date is based partly on an agreed reference rate whether a posted rate or dealer rate. Non-deliverable swap (NDS) constitutes a cash-settled contract (cash-settled swap) which doesn’t involves delivery of the underlying, i.e. there is not physical exchange of the two currency cash flows. Instead, the parties net the difference between the exchange rate set out in the swap contract and the spot rate, and one party pays the other that difference. NDSs are usually settled in U.S. dollars. Multinational corporations and countries with minor currencies (like emerging markets) sometimes use non-deliverable swaps to hedge transfer risk (profit repatriation risk) associated with comparatively illiquid currencies, and to avoid the cost of local market exchange.

The interest rate of the restricted currency is a fixed rate leg and that of the other is a fixed or floating rate leg. Interest rate payments are made on quarterly, semi-annual or annual basis, while the principal amount is paid on maturity of the contract. Any payments in the restricted currency are made through major currency based on prevailing sport exchange rate.

For example, two companies enter into a non-deliverable currency swap for $1 million, which involves exchanging US dollar and a non-convertible currency (say Brazilian real, or BRL for short). If after three months, one of the companies has to pay Brazilian reals worth 1,000,000 to the other company, and supposing the prevailing spot exchange rate is BRL 1.862 per dollar, that company pays approximately BRL1,862,000 (1,000,000 * 1.862).