Question

List and explain four types of nonbank financing? Explain the four types of derivatives and give an example of each

Answer 1

Types of non banking financial :

a) Asset finance company : Main business to finance the assets such as industrial machines, automobiles, material equipments, etc.

b) Investment company : Main business is to deal in securities.

c) Infrastructure finance company : A company which has new owned fund of at least 300 crores and deployed 75% of it's total assets in infrastructure loan.

d) Loan company : Main business is to make loans & advances.

Types of derivatives :

a) Forward contracts : It is an agreement to sell something at future date. Price at which the transaction will take place is decided in the present. Example, spot price in market $110 for particular assets & forward rate is $150 under forward contract then buyer of contract gets net profit of $40 ($150 - $110).

b) Futures contract : This is very similar to forward contract. But future contracts are listed on exchange. Exchange contract come in a pre-decided format, pre-decided size & pre-decided expirations. Example, if contracts are trading at $80 for 100 barrels of oil. They are not required to pay $8,000 ($80 * 1,00). Final profit if buyer sells the contract for $90, he makes profit of $1,000 (($90 - $80) * 100 barrels of oil).

c) Option contract : In option contract, it binds one party whereas it lets other party decide at a later date ie at expiration of contract. There are two types of options : i) call option ii) put option. Call option allows right but not an obligation to buy at later date whereas put option gives right but not an obligation to sell at later date. Example, trader buy an option contract at $3 for 100 shares with strike price of $50. Trader must pay $300 ($3*100 stock). Stock expected price to rise at $70. Trader executes a contract & buys 100 shares @ $50. He pays $5,000. Now, trader can sell this stock for $7,000 ($70 * 100 stock). Trader makes profit of $1,700 ($7,000 - $5,000 - $300) after desiring purchase price & options cost.

d) Swaps : Swap enable the participants to exchange their streams of cash flows. Season are not traded on exchange. It carry large amount of exchange rate risk. Example, swapping a fixed interest rate for floating one.