Islamic derivatives
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Islamic derivatives

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Islamic derivatives Islamic derivatives Presentation Transcript

  • ISLAMIC DERIVATIVES
    • P resented by :
          • A LVEENA R EHMAN S HAH
  • INTRODUCTION
    • WHAT IS ISLAMIC BANKING?
    • Modes Of ISLAMIC BANKING
      • Mudarabah (Profit sharing)
      • Wadiah (Safekeeping)
      • Musharaka (Joint venture)
      • Murabaha (Cost plus)
      • Ijara (Leasing)
  • Islamic Methodology towards Innovation Permanent (Al-Thawabit) Changeable ( Al-Mutaghayyarat )
  • ISLAMIC DERIVATIVES
    • What are derivatives?
    • Requisites For A Shariah Compliant Derivative Instruments
        • Riba (usury)
        • Rishwah (corruption)
        • Maysir (gambling)
        • Gharar (unnecessary risk)
        • Jahl (ignorance)
  • Hedging Products
      • Profit rate swap
      • Forward Rate agreements
      • Islamic Options
      • Cross Currency Swap
  • PROFIT RATE SWAP
    • Interest Rate Swap
    • Islamic Profit Rate Swap (IPRS)
          • Definition
          • Reason
  • ISLAMIC PROFIT RATE SWAP
    • Objectives of IPRS
    • To match funding rates with return rates
    • To achieve lower cost of funding
    • To restructure existing debt profile
    • To manage exposure to interest rate
    • To deepen Islamic Financial Market
  • THE DYNAMICS OF IPRS
    • ABC
    Receives fixed returns Financial Liabilities Financial Assets Islamic Swap Counter Party Receives floating profit rate Pays floating obligations Pays fixed profit rate
    • STAGE 1: Fixed Profit Rate
    ABC Islamic Swap Counter Party ASSET STEP 1 ABC sells Asset to Islamic Swap counter Party at notional principal of RM500k. STEP 2 Islamic Swap Counter Party sells Asset to ABC at notional principal RM500k + mark-up based on fixed profit rate STEP 3 Notional principal amount of RM500k owed by both ABC and Islamic Swap party to each other is set off STEP 4 The net difference i.e. the fixed profit rate in Step 2 is paid to Islamic Swap counter Party by ABC at the agreed interval payment date of say 6 month
    • STAGE 2: Floating Profit Rate
    STEP 1 ABC sells Asset to Islamic Swap counter Party at notional principal RM500k + floating profit rate. STEP 2 Islamic Swap counter Party sells Asset to ABC at notional principal of RM500k. STEP 3 Notional principal amount of RM500k owed by both ABC and Islamic Swap party to each other is set off STEP 4 The net difference i.e. the floating rate profit in Step 1 is paid to ABC by Islamic Swap counter Party at the agreed interval payment date of say 6 month ABC Islamic Swap Counter Party ASSET
    • STAGE 3 – Determination of Subsequent Floating Rate
    Floating Profit Rate (Stage 2) is repeated every 6 months until maturity. 6 MONTHS 6 MONTHS 6 MONTHS 6 MONTHS MATURIT Y ABC Islamic Swap Counter Party ASSET
  • ISLAMIC PROFIT RATE SWAP
    • General Observation 1
    • Floating rate
      • Entering into a new contract
      • (Murabaha or Ijara )
  • ISLAMIC PROFIT RATE SWAP
    • General Observation 2
      • No actual payment of Principal
      • Principle of Muqasa (set-off)
      • “ Contractual rate agreement entered into between two counterparties under which each party agrees to make periodic payment to the other for an agreed period of time based upon a notional amount of principal”
  • FUTURE CONTRACT & ISLAMIC FINANCE
    • The following three contracts in Islamic finance can be considered as future/forward contracts
          • The Salam Contract
          • The Istisna Contract and
          • The Joa’la Contract
  • Features of Ba’i Salam
    • “ Two parties sale/purchase an underlying asset at a predetermined future date but at a price determined and fully paid for today ”
    Objective Difference
    • ‘ The lower Salam price compared to spot is the “compensation” by the seller to the buyer for the privilege given to him’
    Features of Ba’i Salam Beneficial to the seller The predetermined price is normally lower than the prevailing spot price
    • “ To overcome the potential for default on the part of the seller, the Shari'ah allows for the buyer to require security which may be in the form of a guarantee or mortgage”
    Features of Ba’i Salam One sided-Counter party risk It is the buyer who faces the seller’s default risk .
  • Features of Istisna
    • “ A buyer contracts with a manufacturer to manufacture a needed product to his specifications ”
    Price of Product Agreed upon & Fixed . Termination Cancelled before production begins . Payment Time of Delivery
  • Joala Contracts
    • “ The Joala Contract is essentially an Istisna but applicable for services as opposed to a manufactured product.”
    • DEFINITION:-
    • “ A cross currency (CC) swap is a foreign exchange agreement between two parties to exchange a given amount of one currency for another ”
    CROSS CURRENCY SWAP
  • Terms and Conditions
    • Trade-able currency combinations
    • Minimum Principal (EUR 1 million)
    • Standard terms (1-10 years)
    • Financial contract that can be traded separately
    • Interest flows in different currencies
    • Principal amounts are Swapped at the beginning & end of the term
  • Three Stages of CCS 1)- Spot Exchange of Principal 3)- Re-exchange of principal at the maturity of the contract 2)- A continuing exchange of interest payments during the swap's life
    • Islamic Cross Currency Swap
    • Two simultaneous Murabaha transactions:
      • Term Murabaha
      • Reverse Murabaha
      • Murabaha
      • “ A murabaha is a sale arrangement whereby a financier purchases goods from a supplier and then on-sells them to a counterparty at a deferred price that is marked-up to include the financier's profit margin”
      • “ A method where the financial institution , either directly or indirectly, will buy an asset and immediately sell it to a customer on a deferred payment basis. The customer then sells the same asset to a third party for immediate delivery and payment, the end result being that the customer receives a cash amount and has a deferred payment obligation for the marked-up price to the financial institution ”
    Reverse Murabaha(Tawarruq)
  • OPTIONS IN ISLAMIC FINANCE
    • Overview of Istijrar
    • Istijrar involves two parties
    • Bank purchases on behalf of its customer
    • The difference in price is bank’s earning/return
    • P*=Po(1+r)
    • Istijrar could be P* or an average price of commodity between the period t 0 an t 90 .
    • 4. Which party chooses to “fix” the settlement price— embedded option
    • 5. Both parties agree on following two items
    • a) Predetermined murabaha price P*
    • b) Upper and lower bound
    • Po = the price that bank pays to purchase underlying commodity
    • P* = Murabaha price; P* = Po (1+r).
    • P LB = the lower bound price
    • P UB = the Upper bound price
    P LB P 0 P * P UB
    • At Maturity:
    • Ps = Avg price ; if the underlying asset price remained within the bounds.
    • Ps = P*; if the underlying asset exceeds the bounds and one of the parties chooses to exercise its option and use P* as the price at which to settle at maturity.
    OPTIONS IN ISLAMIC FINANCE
    • Basic Idea:
    OPTIONS IN ISLAMIC FINANCE Not A Zero Sum Game Contract avoids “Riba and Gharar”
  • C ONCLUSION
    • “ T hese instruments could easily be used for speculation appears to be the key reason for objection. That derivatives form the basis of risk-management appears to have been lost ”
    Evaluation on precedence Absent for the risk management problems faced today Objective Micro-examination instead of intend and societal benefit Differing Sects Convergence Required
    • T H A N K Y O U !!!