Lets assume you fund in USD at Libor and the Libor curve is flat at 3% 1 year out. You borrow 1Million USD and convert the cash at the current spot FX rate to XXX currency at a rate of 50, which gives you 50Millon XXX. The XXX currency is a restricted currency and the government won’t allow you to invest in fixed income or money market instruments. You plan on keeping your cash for 1 year in XXX currency and engage in derivative transactions. To hedge the FX risk you sell a 1 year NDF non-deliverable forward contract. Currently the domestic interest rates are 15% with a flat curve 1 year out. You sell the NDF at an implied rate of 1.5%. As a foreigner, you will earn 0% if the 50Million XXX is kept in a domestic bank. If the cash is kept in the domestic bank you will hence have a 1.5% loss after 1 year. Now the question is, assuming you use the 50Million XXX to engage in equity, derivative, futures transaction all traded domestically and denominated in XXX, which discount rate should be applied when deriving Fair Value of these instruments?

easy - 1.5% is the rate.

Hello,What is not clear to me is that if you keep 50 MM XXX in a domestic bank and you get nothing, but you could also go to the NDF market and get the 1.5% of the NDF. You will have the same Fx full exposure as if you keep the money in the local bank.In that case, I would say trhat, as your financing cost to replicate your equity forward are the NDFs rates, your equity derivatives should be discounted with the NDF curve, 1.5% in this case.Do you see my point?Regards