Non-convertible currencies, as the name implies, are currencies that cannot be readily exchanged for another currency, generally as a result of government restrictions. The Chinese yuan (CNY) is a well known non-convertible currency. The Chinese authorities do not allow convertibility, in part, as a means to facilitate the managed exchange rate of the yuan (the currency peg).
Non-convertible currencies are not freely traded in the traditional spot or forward currency markets. Rather, investors can replicate an investment in a non-convertible currency using non-deliverable forward (NDF) contracts. An NDF acts like a forward contract for non-convertible currencies, allowing investors to gain exposure to currencies they otherwise would not be able to invest in. Rather than delivering the underlying currency at expiration (as may be the case in a traditional forward currency contract), any profit or loss is settled by making a net payment in a convertible currency, such as the U.S. dollar (USD).