FACTORING

Factoring is a service of financial nature involving the

conversion of credit bills into cash. Account receivables, bills recoverable and other credit dues resulting from credit sales appear in the books of accounts as book credit. Here the risk of credit, risk of credit worthiness of the debtor and number of incidental and consequential risk are involved. These risks are taken by the factor which purchases these credit receivables without recourse and collects them when due. These balance sheet items are replaced by cash received from the factoring Agent.

MEANING OF FACTORING
Factoring is also called as invoice discounting or

purchase and discount of all Receivables. Although these can be with recourse or without recourse, normally the risk is taken by the factoring agent. The discount rate includes the loss of interest, risk of credit and risk of loss of both principal and interest on the amount involved

FACTORING
Many banks have set up subsidiaries for undertaking the

factoring services. The factor buys the bills receivables or other book accounts, only if they are considered good for credit and are acceptable to him for the risk he takes. This service of buying the credit instrument may be a continuous or an adhoc service varying from Bill discounting to total takeover of administration of sales ledger and collection of credit sales ledger and collection of credit sales. Credit function involving granting of limits for cash in conversion of credit receivables include administration of sales ledger, credit control, credit approval, collection of credit bills and credit insurance etc.

FORFAITIING
Forfaiting is a technique by which a forfaitor (financing

agency) discounts an export bill and pay ready cash to the exporter who can concentrate on the export front without bothering about collection of export bills. The forfaitor does so without any recourse to the exporter and the exporter is protected against the risk of nonpayment of debts by the importers.

VENTURE CAPITAL
: A venture capital is another method of financing in

the form of equity participation. A venture capitalist finances a project based on the potentialities of a new innovative project. It is in contrast to the conventional security based financing. Much thrust is given to new ideas or technological innovations. Finance is being provided not only for start-up capital but also for development capital by the financial intermediary.

VENTURE CAPITAL
Money provided by investors to start up firms and

small businesses with perceived long-term growth potential. This is a very important source of funding for start ups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns.

 Venture capital can also include managerial and

technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies or ventures with limited operating history, which cannot raise funds by issuing debt. The downside for entrepreneurs is that venture capitalists usually get a say in company decisions, in addition to a portion of the equity.

VENTURE CAPITAL (VC)

Venture capital (VC) is financial capital provided to

early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology, IT, software, etc.

ADVANTAGES OF VENTURE CAPITAL The primary advantage of venture capital is that they

allow entrepreneurs to build their company with OPM (other people's money). If you need financing to build your technology or product and don't have the money to do it yourself, the idea is that the venture capitalists provides the capital to allow you to build. In exchange, the venture capitalist takes some ownership in your company. The venture capitalist then hopes that your company increases in value and ultimately has a liquidity event (e.g. IPO or sells to another company) so that they can get a return on their invested capital. In addition to capital, venture capitalist can be an invaluable source of information, resources and contacts to help you be successful. More times than not, venture capitalists have experience building companies themselves so they can really help

securitisation
Securitisation is the process of conversion of existing

assets or future cash flows into marketable securities. In other words, securitisation deals with the conversion of assets which are not marketable into marketable ones. For the purpose of distinction, the conversion of existing assets into marketable securities is known as asset-backed securitisation and the conversion of future cash flows into marketable securities is known as future-flows securitisation. Some of the assets that can be securitised are loans like car loans, housing loans, et cetera and future cash flows like ticket sales, credit card payments, car rentals or any other form of future receivables.

Example of securitisation
Suppose Mr X wants to open a multiplex and is in

need of funds for the same. To raise funds, Mr X can sell his future cash flows (cash flows arising from sale of movie tickets and food items in the future) in the form of securities to raise money. This will benefit investors as they will have a claim over the future cash flows generated from the multiplex. Mr X will also benefit as loan obligations will be met from cash flows generated from the multiplex itself.

How banks do securitisation?

In the traditional lending process, a bank makes a

loan, maintaining it as an asset on its balance sheet, collecting principal and interest, and monitoring whether there is any deterioration in borrower's creditworthiness. This requires a bank to hold assets (loans given) till maturity. The funds of the bank are blocked in these loans and to meet its growing fund requirement a bank has to raise additional funds from the market. Securitisation is a way of unlocking these blocked funds.

Practical operation of securitisation

In the traditional lending process, a bank makes a loan,

maintaining it as an asset on its balance sheet, collecting principal and interest, and monitoring whether there is any deterioration in borrower's creditworthiness. This requires a bank to hold assets (loans given) till maturity. The funds of the bank are blocked in these loans and to meet its growing fund requirement a bank has to raise additional funds from the market. Securitisation is a way of unlocking these blocked funds. Consider a bank, ABC Bank. The loans given out by this bank are its assets. Thus, the bank has a pool of these assets on its balance sheet and so the funds of the bank are locked up in these loans. The bank gives loans to its customers. The customers who have taken a loan from the ABC bank are known as obligors.

Special Purpose Vehicle operations

The SPV is a separate entity formed exclusively for the

facilitation of the securitisation process and providing funds to the originator. The assets being transferred to the SPV need to be homogenous in terms of the underlying asset, maturity and risk profile. What this means is that only one type of asset (eg: auto loans) of similar maturity (eg: 20 to 24 months) will be bundled together for creating the securitised instrument. The SPV will act as an intermediary which divides the assets of the originator into marketable securities. These securities issued by the SPV to the investors and are known as pass-through-certificates (PTCs). The cash flows (which will include principal repayment, interest and prepayments received ) received from the obligors are passed onto the investors (investors who have invested in the PTCs) on a pro rata basis once the service fees has been deducted. The difference between rate of interest payable by the obligor and return promised to the investor investing in PTCs is the

DERIVATIVES
The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else.

What is included in derivatives?

In other words, Derivative means a forward, future, option

or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. derivatives are the instruments which "derive" their value from underlying assets. E.g., if their is a share of RIL, RIL-Futures will be the derivative of it since the value of futures of RIL depends on CMP of RIL

 A derivative can be defined as something which

HOW DERIVATIVES OPERATE?

derives its value from an underlying product being a stock, currency, commodity or anything that carries a market price. The market price of a product is subject to fluctuations due to various factors effecting its demand & supply thereby associating itself to various risk factors. SO, derivative is a by-product of the core product which can be used to hedge, speculate & also undertake arbitrage activities

RISK IN DERIVATIVES
A financial instrument whose characteristics and

value depend upon the characteristics and value of an underlier, typically a commodity, bond, equity or currency. Examples of derivatives include futures and options. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. These techniques can be quite complicated and quite risky.

What is a derivative market?

The Derivatives Market is meant as the market where

exchange of derivatives takes place. Derivatives are one type of securities whose price is derived from the underlying assets. And value of these derivatives is determined by the fluctuations in the underlying assets. These underlying assets are most commonly stocks, bonds, currencies, interest rates, commodities and market indices. As Derivatives are merely contracts between two or more parties, anything like weather data or amount of rain can be used as underlying assets. The Derivatives can be classified as Future Contracts, Forward Contracts, Options, Swaps and

DEFINITION OF DERIVATIVES
With Securities Laws (Second Amendment)

Act,1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as: A Derivative includes: a. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; b. a contract which derives its value from the prices, or index of prices, of underlying securities;

 Futures Contract means a legally binding agreement to

WHAT IS A FUTURE CONTRACT

buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash.

WHAT IS OPTION CONTRACT?

Options Contract is a type of Derivatives Contract

which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchases the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc.

IMPORTANT TERMINOLOGY
CALL OPTION: An Option to buy is called Call option. PUT OPTION: and option to sell is called Put option. AMERICAN OPTION: If an option that is exercisable on

or before the expiry date is called American option. EUROPEAN OPTION: THE option that is exercisable only on expiry date, is called European option. STRIKE PRICE OR EXERCISE PRICE: The price at which the option is to be exercised is called Strike price or Exercise price. Therefore, in the case of American options the buyer has the right to exercise the option at anytime on or before the expiry date. This request for exercise is submitted to the Exchange, which randomly assigns the exercise request to the sellers of the options, who are obligated to settle the terms of the contract within a specified time frame.

SETTLEMENT OF OPTION CONTRACT

As in the case of futures contracts, option

contracts can be also be settled by delivery of the underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract.

WHAT ARE INDEX FUTURE CONTRACTS?

Futures contract based on an index i.e. the

underlying asset is the index, are known as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying index.

WHAT ARE INDEX OPTIONS CONTRACTS:

the options contracts, which are based on some

index, are known as Index options contract. However, unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised / assigned only on the expiry date.

HOW INDEX DERIVES ITS VALUE?

An index, in turn derives its value from the prices

of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy. Indices that represent the whole market are broad based indices and those that represent a particular sector are sectoral indices.