What are non-deliverable forwards primarily characterized by?

Non-deliverable forwards (NDFs) are primarily characterized by cash settlement rather than physical delivery. This means that, at the maturity of the contract, the parties involved settle the difference between the contracted forward rate and the prevailing spot rate in cash, rather than exchanging the actual underlying currency. NDFs are commonly used in markets where capital controls or other restrictions make it impractical or impossible to exchange currencies physically. This cash settlement mechanism provides a flexible alternative for hedging or speculating on currency movements in these markets.

The other options mistakenly imply characteristics associated with different types of financial instruments. Physical settlement refers to actual delivery of the asset, which is not applicable to NDFs. Being traded exclusively in the futures market is misleading as NDFs are typically traded over the counter (OTC), not on an exchange like traditional futures contracts. Lastly, the notion of guaranteed delivery of the underlying asset does not apply to NDFs, as they do not involve physical delivery at all. Therefore, the ability to cash settle rather than deliver physical currency is the hallmark of non-deliverable forwards.