Syed hassan s hahbaz thesis islamic banking & finance project sukuk investments & sukuk structure

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Thesis Report
Islamic Banking & Finance
Research Thesis
Islamic Sukuk Investments
Evaluation of ResearchDevelopments
on the Islamic Securities (Sukuk)& Structure of Sukuk
Prepared By Syed Hassan Shahbaz
MBA/Adv/1-17/GH003
MBA (Finance) DadabhoyInstitute of Higher Education

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Certification Letter
This dissertation Titled “Islamic Investment Sukuk” For “Evaluation of Research
Development on the Islamic Securities (Sukuk)” of Finance and Submitted by Syed Hassan
Shahbaz Shah for the degree of Masterof Business Administration in (Finance) is here
accepted.
……………………………………..
External Examination

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Declaration Letter
This Thesis Demonstration ofmy unique research work Where ever the Influence of
Other are Involved Every Struggle is made to specify this clearlywithdue reference
to the Literature and Acknowledgement of Collective Researchand Discussion.The
work done under the guidance of professor at the Dadabhoy Institute of Higher
Education.
2nd - Jan- 2019

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Dedications
I would like to dedicate this Thesis to My Mom & Dad & Also my Teachers who are supporting
me on every Life step. Our Dadabhoy Institute teachers are grooming us. My Mom and Dad are
very support me, My Dad is so friendly with me and they are able to me. I do something in my
Life. I would like to Say Special Thanks to My Class fellow’s & My Teachers who supporting us On
every step & every turn on the MBA Studies & Entire Management of Dadabhoy Institute ofHigher
Education Karachi.
Regards
Syed Hassan Shahbaz

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Letter of Acknowledgement
It is my esteemed pleasure to present the thesis on “Islamic Sukuk Investments & Structuring”
I express my deepest gratitude to Mr. Aurangzeb who gave me the inspiration to pursue the topic
and guided in this endeavor. He has been a constant source of motivation and encouragement for
me and that’s I thankful for all the initiative and zeal he filled.
Also my profound sense of gratitude to him to taught the Excel software needed for analysis, he
was a valuable guide.
Last but not the least, I am thankful to Dadabhoy Institute for equal contribution, for the co-
operation and the efforts put in. I have been Teach with very Talented & Good Faculty Teachers I
would like to thank all the people who direct and in-direct helped to complete this project.

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Table of Content
1. Letter of Certification ……..…………………………………………………..………….2
Letter of Declaration………………………………………………………………………3
Letter of Dedication……………………………………………………………………….4
Letter of Acknowledgement………………………………………………………………5
Abstract ….………..………………………………………………………………………9
Chapter No 1 Introductions
1 Introduction…………………………………………………………………………10
1.1 Core of Evaluation Study………………………………...……………………10
1.3 Scope of the Evaluation Study…………………………………………………10
1.3 Significance of Evaluation……………………………………………………..10
1.4 Research Objectives & Research Questions…………………………………...……11
Chapter No 2 Literature Review
2 Literature Review………………………………………………………………………..12
2.1 Introduction of Sukuk …………………………………………….…………………12
2.2 First: The historical Emergence & Spread of the Islamic Securities In the Islamic
Capital Markets………………………………………………………………………….13
2.3 Emergence of Securitization in the Muslim world………………………………….13
2.4 Definition of the Concept………………………………………………………...13-15
2.5 VAR…………………………………………………………………………………16
2.6 Conclusion………………………………………………………………………….17
2.7 Main Types of Sukuk…………………………………..........................................17
2.8 Main Structure of Sukuk…………………………………………………………18-19
Chapter No 3 Classification ofResearch Work
3.1 Second: Classification of Research Conducted into different Focus Area…………20
3.2 Religious Motive ...................………………………………….………………..20
3.3 Profit Driven Motives……………………………………………………………20
Chapter No 4 Growth
4.1 Growth in terms of Diversification in Asset Types & Classes…………………….21

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4.2 Growth In terms of Monetary Volume ……………………………………………21
4.3 Banking Perspective……………………………………………………………….21
Chapter No 5 Factors
5.1 Factors …………………………………………………………………………….22
5.2 (c) Legal/Shariah Perspectives………………………………………………….22-23
Chapter No 6 Research Methodologies
6.1 The Research Methodologies ……………………………………………………….24
6.2 The Quantitative Research…………………….……………………………….........24
6.3 The Qualitative Research……………………………………………………………24
6.4 The Fourth: Conceptual Focuses of Research Papers……………………………24-25
6.5Sixth Classification of Research work in term of Languages Used………………..25
Chapter No 7 General Structure ofSukuk
7.1 General Structure of Sukuk……………………………………………………........26
7.2 Figure (2-1) …………………………………………………………………………26
7.3 Conclusion…………………………………………………………………………..26
7.4 Data Analysis ……….………………….…………………………………………..27
7.5 Basic Data Descriptions…………………………………………………………..27-28
Table 4.1 ………………………………………………………………………………..28
Chapter No 8 Data Analysis
8.1 Data Analysis……………………………………………………………………..29
8.2 Hypothesis………………………………………………………………………..29
8.3 Figures (4-1) (4-2)………………………………………………………………..29-32
Figures (4-3) (4-4), (4-5) (4-6), (4-7) (4-8), (4-9) (4-10), (4-11) (4-12), (4-13) (4-14)
(4-15) (4-16)…………………………………………………………………………29-32
8.4 Conclusion………………………………………………………………………...32

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8.5 Methodology…………………………………………………………………….32
8.6 Definition of VaR………………………………………………………………..32
8.7 VaR Models……………………………………………………………………..33
8.8 Mathematical Foundations for the Data………………………………………34-35
8.9 VaR Model Building Processes…………………………………………………35
8.10 Conclusion…………………………………………………………………….35
Chapter No 9 Application to Sukuk & Conventional Bond
9.1 Application to Sukuk & Conventional Bond…………………………….……..…36
9.2 Defining the Portfolio & Identifying its risk for model......................................…...36
9.3Table (5-1), (5.2), (5.3)……………………………………………………………36-37
9.4 Setting the Basic Parameters for the Model…..……………………….………….38
9.5 Value At Risk Calculation…………………………………………………………38
9.6 Table (5-4)………………………………………………………………………….38
9.7 Discussion………………………………………………………………………….38-39
9.8 Market Risk…………………………………………………………………………39
9.9 Credit Risk…………………………………………………………………………..39
9.10 Shariah Compliance Risk……………………………………………………….40
9.11 Correlation between Sukuk………………………………………………………40
9.12 Findings & Recommendation……………………………………………………41
9.13 Recommendation…………………………………………………………………42
9.14 Conclusions……………………………………………………………………43-44
9.15 References……………………………………………………………………….45-47

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Abstract
Muslim international locations of the developing world go through indebtedness resulting often
from investment improvement infrastructure. Faced with a dire need for development
infrastructure however with insufficient resources to fund them domestically, those governments
frequently hotel to foreign borrowing. As neither foreign banks nor international debt markets
might allow for the debt to be in domestic foreign money, the investment is always denominated
in foreign money. For the borrowing U. S. A., similarly to foreign money publicity such
borrowing will increase the country's leverage and monetary vulnerability. As these nations
typically have a narrow financial base with heavy reliance on commodity exports, they are
susceptible to the vagaries of commodity rate fluctuation. Leverage will increase the amplitude
of the financial system's fluctuation, resulting if no longer in outright crisis, then, at least in
financial distress and depreciating home currency. As a end result, whilst the overseas currency
funded project comes on flow, it's far careworn with huge collected debt which in lots of cases
makes the challenge unmanageable without similarly authorities help through subsidy of
running costs. This similarly stresses already stretched authorities budgets and perpetuates
indebtedness. This cycle of borrowing, leverage and vulnerability may be damaged by means of
innovative use of Sukuk. The hassle with debt financing is that the servicing necessities are
impartial of the underlying venture's hazard or cash flows. This paper presents Sukuk structures
primarily based at the risk sharing ideas of Islamic finance. Sukuk which have returns linked to
the nation's gross domestic product increase if the funded assignment is non‐revenue generating
and related to profits of the venture if its miles revenue producing can avoid the issues above.
The pay‐off profile, envisioned value of funds and returns to investors of these Sukuk are
discussed. While designed in small denomination, such Sukuk can decorate financial inclusion,
help build domestic capital markets and allow the financing of development without stressing
authorities’ budgets of the evaluation.

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Chapter # 1 Introduction
1.1 Core of the Evaluation Study:
The middle of these studies is targeted on the instructional studies written on the Islamic
Sukuk for the reason that emergence of this concept in the Muslim global, by means of
accumulating some of the exceptional papers written on the topic, searching at the troubles
raised, the answers given, and the advice suggested by using the students for further
improvement. The Study then assesses and evaluates those studies works for you to gain the
objectives of the evaluation.
1.2 Scope of the Evaluation Study:
This study is going to evaluate some of the most significant academic work on the
Topic of Sukuk from the year 2000 until 2007. Although the main time scope of the
Study is 2000-2007 when majority of the research work was done, the study may use the
Few research conducted earlier. The data sources of this evaluation study come from
Four main areas as follows:
1.3 Significance of the Evaluation Study:
This evaluation workout can be a helpful observes for academicians who need to have a few
background on the extent of studies in the Sukuk place. It’s also useful for government, private
Islamic economic establishments, and buyers who are inclined to take Steps ahead in managing
Sukuk. Such comments are also very crucial and beneficial for the fact that it aids in choice
making and policy system.
1-Islamic Financial Institutions:
- IRTI. (Islamic Research & Training Institute)
- IFSB. (Islamic Financial Services Board)
- AAOIFI. (Accounting & Audition Organization for Islamic Financial)
- SC of Malaysia. (Securities Commission of Malaysia)
- IIFM. (International Islamic Financial Market)
2- Conference and Seminar paper
3- Academic research papers:
- Journals.
- Thesis.

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1.4 Research Objectives & Questions:
Objectives of the Evaluation Study:
This evaluationstudyis trying to achieve the following objectives:
 To provide basic understanding of the concept of Sukuk and its emergence.
 To assess and evaluate the level of research achievement on the topic of Sukuk.
 To assess effects of the research works on the theoretical and practical applications of the
Sukuk concept.
 To explore some of the most significant research work in the area of Sukuk.
 To provide an academic work that could be used as framework for further
Research in the area.
 To provide useful feedback to the different groups of stakeholders those have Direct or
indirect interest in this Sukuk. .

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Chapter # 2 Literature Review:
2.1 Introduction of Sukuk:
The Shariah compliant bond best definedas Sukuk has become one of the most dynamic
tools for capital mobilizationinboththe Islamic and conventional capital markets. Long
since its first emergence facedanumber of legal and Shariah challenges alongwith other
operational challenges which naturally necessitatedindividual and group efforts bythe
Governments, academic institutions, and corporate bodies to find Solutions andalso to
explore the best approach towards dealing with this new product. Although there were
issues of Riba free certificates bythe Islamic Bank of Malaysia in the 1990s, Sukuk was
recognizedas an important Islamic capital market instrument inthe 2000s whenit began
in a dynamic way and soonstarteda rapid growth and spread with a widely acceptance
not by the Muslim investors but also by the non-Muslim around the globe. This rapid
development in the Sukuk issue was accompanied and supportedwith another
development in the academic researchwhich in a way or another.
Recently in Italy, an Increasing interest from government and corporate has
Been noticed to use Sukuk to fund their project, and this desire was due to the
Globally increase in using Sukuk. Thomson Reuters report expects Global outstanding Sukuk
issuance to grow to $907 billion by 2020.Islamic Finance Gateway. (2014) In recent years,
the international Sukuk market has grown considerably, with Sukuk issuances surging not
only by volume and value, but also in the geographical scope of the issuing markets, the
value of international Sukuk issued in 2014 reached US$114 billion, of which 85% was
issued by sovereign and quasi sovereign entities, Several factors are driving sovereigns to
participate in the Sukuk market, including: the desire to establish a benchmark and to
encourage the development of a corporate Sukuk market in the relevant country or territory,
as well as the need to develop a legal and regulatory framework that recognizes and
facilitates the issuance of Sukuk especially in jurisdictions where Islamic principles are not
enshrined in national law. But the expectation that sovereign and quasi sovereign issuances
would pave the way for corporate to issue Sukuk has not so far materialized, (IRVINE, 2015)
because most of the corporate still have ambiguity in accounting practice for issuing Sukuk,
and lack of knowledge about the legal and regulatory framework. The term Islamic finance
encompasses any type of financial activity that is undertaken in accordance with Islamic law
(Shariah). Sukuk is a generic term used to encompass a broad range of financial instruments
designed to conform to the principles of Islamic law (Shariah). Although many Sukuk
structures are designed to replicate the economic function of conventional bonds, their legal
structures are different. Classifying Islamic financial instruments, including Sukuk, under
existing regulatory frameworks has posed challenges in the UK and other jurisdictions.
(HM Treasury, 2009) The interests on Islamic accounting has been growing for the past two
decades, however, the development of Islamic accounting is still at the infancy stage.
(Rahman and Rahim, 2003)Due to the growth in the Islamic finance particularly Sukuk, the
need for specific accounting standards, which account for the issuance transactions and
Islamic contracts, is an essential issue. This study will explore only the accounting treatment
for Sukuk issuance transactions, because the researchers take into consideration the existence
of different jurisdiction schools in Islam, which could cause the variation in Fatwa and
implications of Islamic finance instruments.

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2.2 First: The historical emergence and spread of the Islamic securities inthe
Islamic Capital market:
Before talking about the emergence and spread of the Sukuk concept in the Muslim
World, it is important to understand the source and origin of the practice. Securitization
emerged in the USA, in the 1970s (1), when Ginnie Mae issued Pass-through
Securities collateralized by a pool of mortgage-Backed loans which were Guaranteed by the
U.S.A. government, and then these papers were sold to the investors. Since then this
phenomena continued spreading in the U.S. and Europe through 1980s. In the 1990s
Securitization became a very important product in the international capital market not only
confined to Mortgaged-Backed Securities, but other types of asset backed Securities also
were issued. As a result the total asset-backed securities in the med-nineties reached US$.
400 billions despite the weak economy of the world at that time.
2.3 Emergence of securitizationinthe Muslim world:
With the exception of few Shariahcompliant products, the Islamic capital market
Before the 1990s has been operating in a similar manner with the conventional western
Capital market. In the year 1983 the central bank of Malaysia has tried to issue
Investment papers that involve Riba free instruments. That could be said to be the first
Attempt of issuing Shariah compliant certificates. In the 1990s other financial institutions
In the Muslim countries including Malaysia such as Pakistan and Egypt issued securities
Which were more or less similar to the conventional securities with a little bit of?
Improvement. These Muslim countries in the beginning of the year 2000 started issuing
Completely Shariah compliant certificates. The first Sukuk issuance was by Malaysia in
the year 2000 followed by Bahrain in 2001 and then Indonesia in 2002, letter other
Muslim and non Muslim country joined the exercise. As per the year 2007 there are 13
Major countries where Sukuk were issued, 9 of which are Muslim countries.
2.4 Definitionof the concept:
“Sukuk” or “‫كوك‬ ‫ص‬ ” is the plural of “sakk” or “‫صك‬ ”, which means "legal
Instrument, deed, check2" is the Arabic name for a financial certificate but can be seen
As an Islamic equivalent of bond. However, fixed income, interest bearing bonds are not
Permissible in Islam, hence Sukuk are securities that comply with Shariah hand its
Investment principles, which prohibits the charging, or paying of interest. Financial
Assets that comply with the Islamic law can be classified in accordance with their
Tradability and non-tradability in the secondary markets3. The concept has been used
During the medieval Islam and related to recording of financial and other obligations.4
The word Sukuk in its meaning had also been used by Western Europe, and later
Became what is presently known in the Latin word as “cheque”.
In the modern Islamic financial terms Sukuk is defined as the Islamic or the Shariah
Compliant bond. Other Arabic terms of Sukuk are Islamic investment certificate.
According to the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI) in its standard 17, investment Sukuk are certificates of equal value representing
after closing subscription, receipt of the value of the certificates and putting it to use as
planned, thus it represents a common shares and rights in the underlined assets or their
usufructs and services5. AAOIFI has classified Sukuk into 14
Types depending on the contracts used, among these, Sukuk Al- Ijarah (lease based
certificates) is the most widely used type of Sukuk.
El-Gamal (1999) discussed the relevant aspects of Islamic law which governs the
issuance and sale/resale of government papers in the open market operations (OMO), and the
various instruments that is used and their effectiveness, moreover El-Gamal looked at the
problem caused by the different opinion among Islamic jurists on the admissibility of the
OMO instruments, and how this mis-matching has lead to governments papers not accepted
by targeted banks. He suggests that central banks should engage in reverse financial

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Engineering to issue papers which target banks would accept. Furthermore, he noted the
problems associated with construction of Islamic bonds and PLS concept which may lead to
sacrificing the security of the principle offered by conventional securities in the OMO
instruments, and finally suggests that a smoothed version of PLS modes or selling an option
at no price with the debt sold at the face value. Khan (2007) and Jobst , Kunzel ,Mills and Sy
(2008) also addressed the conflict of diversity in Shariah scholars opinions and argued that
despite this mis-matching between Shariah scholars opinions, this diversity has contributed
to the global growth of Islamic finance instruments. However, Khan (2007) argued that this
could become a constraining factor in the global growth if the challenges arise out of
diversity in Shariah scholars are not institutionally recognized and regulated. The absence
of Islamic finance derivatives has also been a subject of debate among scholars. Jobst and
sole (2012) outlined a view towards developing a cohesive theory of derivatives that is
subject to Shariah principles. They critically reviewed accepted contracts and scholastic
debate surrounding the existing innovation in the area of financial derivates and argue that a
considerable number of Islamic finance contracts and instruments have derivatives-like
features that can help reducing risk or even can form the basis for engineering Sharia’h
compatible derivatives. Jabeen and Javed (2006) discussed the structure of the Sukuk and
analyzed the concept of PLS and its role in wealth circulation or concentration.
They examined the Sukuk features and underlying structure. Moreover, they chose two
criteria to test PLS and wealth circulation or concentration. They highlighted the main types
of Sukuk ( Salam, istisna’a,murabaha,musharakah,mudarabah and further discussed three
specified types which are share cropping ,irrigation and agricultural Sukuk) and concluded
that Sukuk has the flexibility to mould the financial requirements and constraints and
investment opportunities according to Shariah , as well as meeting the market demand and
supply requirements. Tariq and Dar (2007) and Zaidi (2009) discussed the Sukuk structure
and both investigated the risk associated with Sukuk. Zaidi (2009) concluded that the risk of
Sukuk are broader than the risk of its conventional counterpart because it is inherited with
other risk factors rather than the credit risk which are market risk, risk associated with the
asset underlying Sukuk and the regulatory risk. However, Tariq and Dar (2007) contributed to
the Sukuk literature by introducing a unique type of derivatives that can help in Sukuk risk
management and comp line with Shariah principles. They argued that introducing
embedded options can be part of Islamic finance contracts like leasing, installments sale and
Salam contracts. But however, they stated that these options will not be a derivative as they
cannot be detached and sold independently as an instrument. They also suggested that using
swap between floating rate Sukuk (FRS) and fixed rate zero-coupon embedded Sukuk (ZCES)
has the opportunity to emerge, through creative Shariah compatible financial engineering,
and as a result Sukuk can also become highly competitive in the market and more accessible
to investors and enables satisfaction of greater variety of investments.
Ab Majid, Shahimi and Abdullah (2011) and Ahmad and Ab. Wahab (2012)
discussed the issue of Sukuk default. Ab Majid Shahimi and Abdullah (2011) investigated the
Sukuk default implications on the capital market and took Malaysian capital market and
three defaulted corporate Sukuk as a case study. And they also investigated the implication of
Sukuk default on a countries reputation, the legal aspects of this event and the on the
investor’s protection. They found that Sukuk did not pose significant threat to the Malaysian
local capital market but it has an impact on the overall country reputation as a global Islamic
finance hub. They also found that the investor’s sentiment for Sukuk issuances has been
severely damaged. Amhad and Ab. Wahab (2012) results added to that reached by Ab Majid,
Shahimi and Abdullah (2011) that estimating the Sukuk distance-to default (dtd) reflected the
economic conditions of the real economy and the financial position of the borrowers.
Wilson (2008) provided an analysis of different Sukuk types from a financial
prospective; he examined murabaha, ijara and musharakah Sukuk. He examined and
Explained Sukuk pricing issues, and assess whether the payments flows are stable in the case
of sovereign Sukuk when the return are based on the gross domestic product rather than fixed
interest in the case of Saudi Arabia and Malaysia sovereign Sukuk, and the results he found
was that the GDP-based pricing benchmark would have resulted in less payments volatility in
the Saudi Arabia sovereign Sukuk but not for Malaysians. Wilson added that special purpose
vehicle (SPV) are a prerequisite for the successful issuance and management of Sukuk he
noted the growth of Sukuk market in terms of quantity but he emphasis that now it needs to
shift to quality advancements. Usmani(2006) introduced a paper in which he evaluated the
nature of conventional fixed income securities from the Shariah perspective and illustrated

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the reason for its impermissibility, and introduced Sukuk as alternative and discussed its
different types and setting Sukuk from Bahrain and Pakistan as case studies.
Number of papers investigated the effect Sukuk imposes on the investment’s
performance in different type of financial institutions. In very recent study Said (2011)
provided an interesting study in which he investigated whether the use of Sukuk have
impacted the performance of Islamic banks during the financial crisis, he focused on fourteen
Islamic banks that used these instruments as part of their investment operations. Said divided
his study into two stages, in the first stage he used the financial ratios to measure the strength
of financial liquidity, deployment, overall efficiency and profitability. While in the second
stage he worked out a regression analysis to measure the sensitivity of using Sukuk in these
banks to their performance during the financial crisis. He concluded that the Islamic banks
has decreased in strength deployment overall efficiency and profitability during 2008
compared to 2007, and that Sukuk has not impacted the performance of the sample Islamic
banks. Not much in-depth analysis has been noted about Islamic hedge or mutual funds that
use Sukuk rather than conventional bonds, and fund management opportunities and risk
involved compared its conventional counterpart hedge funds and wealth management pools.
Two papers were noted on this field, the first was presented by Wilson (2007) as he discussed
Islamic asset management different tools including equity, commodities and Sukuk. Lastly
Wilson highlighted the information sources for Islamic asset managers and client advisors
such as IFIS1 which is important for hedge funds managers, and he concluded that Shariah
compliant investors are no longer at a financial disadvantage because of their religious beliefs
however, Wilson mentioned that there remains much scope for further expansion in terms of
breadth through product offering and in terms of depth as increasing the trading volume of
Sukuk and Shariah compliant mutual fund markets in order to provide more price stability
and reduced volatility. The second paper was presented recently by Mansor and Bhatti (2011)
as they evaluated the performance of Islamic and conventional mutual funds in Malaysia in
the period of 1996-2009 using aggregate returns of 128 Islamic mutual funds and 350
conventional mutual funds. They found that both portfolios have performed better than the
market portfolio and in the same time the Islamic portfolio provided slightly less returns
compared to the conventional portfolio, and resulting in a higher risk too. It’s worth noting
that this study importance rises from the fact that few studies have been previously conducted
on Islamic mutual funds performance.
Godlewski et al (2011) and Ariff and Safari (2012) reached a similar result that Sukuk
is distinguished from conventional bonds. However, Godlewski et al (2011) investigated it
from the market reaction prospective. They investigated the market’s reaction towards Sukuk
issuance trying to illustrate an understanding of the investor’s behaviour in the Sukuk market.
They used a market-based approach on Malaysian data they used a standard market model to
estimate abnormal returns around the event of issuing Sukuk and conventional bonds, their
results was that stock market is neutral to announcements of conventional bonds issuance
while it reacts negatively to the issuance of Sukuk .they attributed their results to two ideas.
The first idea is that investors expect this negative reaction to encourage low profit
companies to prefer Sukuk in financing over conventional bonds. The second idea the
researchers suggest is that companies that issues Sukuk tend to be in weaker financial position
than companies issuing conventional bonds. In addition they added that the negative reaction
towards Sukuk issuance affect the firm value at least in the short term. Finally the study noted
the need to assess the long-run implications of Sukuk financing in economic development
before considering large-scale adoption of Islamic finance instruments. On the other hand
Ariff and Safari, (2012) examined the deference between Sukuk and conventional bonds by
examining the presence of any causal relationship between the yield of Sukuk and
conventional bonds of same return and ratings. Their results found no casual relationship.
Cakir and Raei (2007) narrowed their investigation about distinguishing between
Sukuk and conventional bonds to examine the impact of Sukuk on the value-at-risk (VaR) of a
fixed income portfolio using a sample of sovereign Sukuk and Eurobonds issued by the same
issuer, they constructed two hypothetical portfolios the first consists of only Eurobonds and
the other consists of mixture of Eurobonds and Sukuk, they concluded that the Sukuk reduced
the VaR in the second portfolio. This study is widely referred to as far as risk comparison
between Sukuk and Conventional bonds are concerned using quantitative methods. However,
when measuring the diversification gains from Sukuk in a portfolio it should also be evaluated
against the low returns and the liquidity risk inherited with Sukuk,as this illiquidity imposes
more risk on the portfolio at times of volatility. Moreover, the authors have created separate
portfolios for each country rather than creating a diversified global portfolio and excluded

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corporate bonds from their study which might draw a practical restriction on interpreting their
results.
2.5 VaR
In early studies Wirch (1997) and Christopher et al (1998) examined and discussed
Value-at-Risk as an appropriate risk measurement and its advantages and disadvantages.
Wirch (1997) argued that Value-at-Risk measures have two problems that create a main
shortcoming of this methodology. She argued that Value-at-Risk measures can be super
additive and manipulated with the usage of calls and puts along with creation of subport folios.
Furthermore, Wirch (1997) suggested two solutions to these problems. The first is
understanding Value-at-Risk as an extreme value measure and the second solution is using
the mean excess function to identify fat tails and anomalies that occurs in the aggregate loss
distribution tail. Whereas, Cristopher et al (1998) illustrated two points to be minded when
applying Value-at-Risk. First they stated that Value-at-Risk is applicable only for the
measurement of total value risk. Second they argued that Value-at-Risk estimates can be
extremely misleading when Value-at-Risk are analyzed with no estimates of the
corresponding expected profits especially for firms that are deliberately taking risk as part
of its primary business. Hendricks (1996) and Lechner and Ovaert (2010) discussed the
limitations drawn by one of the basic assumptions which is that the returns of portfolio are
normally distributed. They noted that in extreme volatility periods an extreme returns will be
typically larger and its occurrence might not be captured by normal distribution. Hwang and
Pedersen (2004) suggested that in order to solve the problem of non-normal distributed data
in Value-at-Risk application it is necessary to use higher moments (i.e. Skewness, Kurtosis).
Earlier the power-ARCH (PARCH) and the asymmetric PARCH (APARCH) were
introduced by Ding et al (1993). Their contribution was that they provided a model that
utilizes a power term that is optimized within the model rather than been estimated by the
researcher in the GARCH or ARCH models. Huang and Lin (2004) and Bormetti et al (2007)
compared APARCH model in the case of normal distribution and the case of student-t
distribution with estimates taken from GARCH model to forecast Value-at-Risk, and found
that when returns involve fat tails and volatility clustering, the normal APARCH produces
more accurate Value-at-Risk values, while in high confidence levels the student-t APARCH
performs better.
Al Janabi (2007) tested the risk parameters for large foreign-exchange portfolios. He
used the variance-covariance approach taking 40 different countries of both developed and
emerging economies as a case study. He found that a number of realistic case studies are
achieved with the objective of setting up a practical framework for markets risk
measurement, management and control reports. Al Janabi (2007) suggested that despite the
departure from normality in the distribution of returns it is possible to handle these issues for
foreign-exchange cash instruments with the use of variance-covariance method along with
incorporation of a credible stress testing approach as well as by adding realistic illiquidity
risk factor that take into account real-world trading circumstances.
Unlike Al Janabi (2007), Bredina et al (2004) argues that the orthogonal GARCH
model are more accurate compared to Value-at-Risk methods when having equally weighted
portfolio with returns normally distributed based on the exposure of foreign- exchange risk
and specifically for small open economies. However, Value-at-Risk can be implemented for
the use of asset management and to estimate the market risk in the long term horizon Culp et
al (1998). They argued that Value-at-Risk implementation in portfolio optimization and risk
measurement adds the benefit of allowing the risk-return trade-off to be analysed for various
associated levels of confidence. The authors in their paper developed a portfolio selection
model which allocates the financial assets by maximising the expected return subject to the
constrain that maximum loss should meet the Value-at-Risk limits set by the risk manager.

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2.6 Conclusion
Literature on Sukuk can be classified into three groups. The first group distinguish
between Sukuk and conventional bonds based on their structure, properties and how market
views them as different investment alternatives. The second group of literature discussed the
regulatory and legal challenges that face Sukuk global market growth and tried to provide
solutions for regulatory conflicts that is inherited in Sukuk structure and its derivatives
engineering. The third group of literature investigates risk associated with Sukuk and its
implications on Sukuk return performance. Although most literature has agreed such as (Arif
and Safari, 2012), (Godlewski et al, 2011), (Wilson, 2008) and (Cakir and Raei, 2007) that
Sukuk provides an alternative investment, the debate whether Sukuk provides an efficient
investment is still ongoing. However, there is no sufficient empirical support for the favour of
Sukuk being efficient alternative investment to conventional bonds.
On the other hand literature drawn on the usage of VaR in portfolio risk analysis
provided set of empirical studies that despite variation in its results and conclusions it
concludes in general that VaR can be an accurate and proper portfolio risk measurement tool
under certain conditions regarding the data statistical properties. However, some literature
has argued that other models can estimate the volatility of returns more accurately at extreme
volatile periods than VaR can do.
Only one published paper was noted to implement Value-at-Risk approach in
measuring Sukuk risk compared to conventional bonds, which was presented by Cakir and
Raei (2007). This paper aims to bridge the gap in Sukuk risk analysis.
2.7 Main Types of Sukuk
1- Pure Ijarah Sukuk
These certificates are issued on stand-alone assets that are identified on the balance
sheet. The assets can be real state such as factory or fixed assets to be leased such as aircraft
and ships. The rental rates of returns on this type of Sukuk can either be fixed or floating
depending on the originator.
2- Variable rate redeemable Sukuk
Musharakah term finance certificates (MTFCs) can be considered as an alternative to
Sukuk because of their seniority to the issuer’s equity, their redeemable nature, and their
Relatively stable rate as compared to dividend pay-outs. These certificates have two main
Advantages. First, employing Musharakah returns is preferred from the viewpoint of jurists,
as such an arrangement would strengthen the paradigm of Islamic banking that considers
partnership contracts that are based on Loss and Profit sharing principle (LPS) as the
Embodiment of core ideals. Second, the floating rate of return on these certificates would not
depend on benchmarking with market references such as LIBOR but would instead be
Contingent on the firm’s balance actualities.
3- Fixed-rate zero-coupon Sukuk
These are type of Sukuk when the assets to be mobilized do not yet exist.
Consequently, the objective of the fund mobilization would be to create more assets on the
Balance sheet of company through Istisna’a contract however, these certificates would not
Readily be tradable because of Shariah restrictions. The primary asset pools to be generated
From these certificates would be of nature warranted by Istisnah ‘a contracts and installments
Purchase/sale contracts that would debt obligations.

18
4- Hybrid/Pooled Sukuk
These types of Sukuk combine two or more forms of Islamic finance contracts in their
Structure such as Mudharabah and Ijarah structures. It allows greater mobilization of funds.
2.8 Main structures of Sukuk
1- Pure Sukuk al-Ijarah
These types of Sukuk can be used for the mobilization of funds for long term
Infrastructure projects. This happens through the securitization of tangible assets such as
Lands, roads, airports buildings, etc. and offering Sukuk to a large number of institutional and
Individual investors. The parties’ involved in Sukuk al-Ijarah are the issuer (SPV) as issuer
And as trustee, the originator as seller, lessee and obligator (under purchase undertaking and
under sale undertaking) and as servicing agent as well as the subscribers whom invest in the
Sukuk.
2- Sukuk al-Mudharabah
These types of Sukuk are certificates that represent projects or activities managed on
the Mudharabah contract principle by appointing any of the partners involved in the deal as
Mudarib for the management of the business. The parties involved in the Mudharabah are the
Mudarib who is the issuer, the subscribers are the investors in the Sukuk and the realized
Funds are the Mudharabah capital. Moreover, the Mudharabah Sukuk holders own the assets of
the Mudharabah and the agreed upon share of the profits belongs to the owners of capital and
they bear any loss occurred.
3- Sukuk al-Musharakah
These are certificates of equal value issued for the mobilization of funds to be used on
The basis of partnership, were their holders become owners of the relevant project or asset as
Per their shares that are part of their asset portfolios. These types of Sukuk can be issued as
Redeemable certificates by or to the corporate sector or to individuals for their rehabilitation,
Purchase of automobiles for commercial use or for the establishment of hospitals, factories,
Etc. Musharakah Sukuk is mode which can serve for the securitization of assets in big
Projects where huge amount of capital are required. The parties involved in the Sukuk al-
Musharakah are the issuer who is the inviter to a partnership in a specific project or activity.
The subscribers are the investors in the Sukuk partners in the Musharakah contract. The
Mobilized funds are the share contribution of the subscribers in the capital. And the certificate
Holders own the assets of the partnership and they are entitled to any profit realized.
4- Sukuk al-Salam
These types of Sukuk are based on Salam principle in which advance payment of
Price is made for goods to be delivered in a certain time in the future. It is certificates of
Equal value issued for the sale of mobilized capital that is paid in advance in the shape of
Price of the asset to be delivered in a certain time in the future. A Salam purchase can
Onward sell the Salam asset by another contract which is parallel to the first contract. Parties
Involved in Sukuk al-Salam are the issuer who sells the Salam asset, the subscribers are the
buyers of that asset, the mobilized funds which are the purchase price of the asset, which the
Salam capital and certificate holders whom are the entitled to the Salam asset, the Salam
Price or the price of selling the on parallel Salam basis, if any.

19
5-Sukuk al-Istisna’a
These types of Sukuk are based on Istisna’a principle in which an agreement for
Manufacturing goods and allowing cash payment in advance and delivery at a certain time in
The future. In Istisna’a full ownership of the constructed item is immediately transferred upon
Delivery of the item to the purchaser, against the differed sale price that might also include
Any profits which legitimately covers the cost of tying funds for the period of the repayment.
It is certificates of equal value and is issued with the aim of mobilizing funds required for
Producing a certain item or asset.

20
Chapter # 3 ClassificationofResearchWork
3.1 Second: Classifications ofthe research workconducted into different
Focus areas:
Based on the samples of this evaluation study which was taken from the three main
Sources mentioned earlier, the study made classifications of the research works into
Three fundamental periods:
(1) Early research: Research conducted before the year 2000.
(2) Middle research: Research conducted from 2000-2003.
(3) Latest research: Research conducted from 2004-2018.
Although research conducted throughout the study period might have discussed
Similar issues, these issues have been addressed in more depth in the later research
Works compared to the earlier ones.
The following is a brief description of the focus areas of the research conducted
Through the study period. In addition to what has been briefly mentioned earlier,
Generally all the research in the sample have discussed some the following issues briefly
Or in details. For the purpose of clarification I have categorized these issues into some
Main headings and are discussed in more detail:
(a) Economic perspective:
In this part the evaluation study the research work from the sample collected
Discussed the economic perspectives of the Sukuk issue, focusing on the growth in
Various aspects of the Sukuk issues as follows:
1- Growth in the scope:
Some research conducted discussed the quick spread and expansion of Sukuk issues
In the Muslim countries through the engagement of a number of financial institutions in
Issuing Shariahcompliant securities, these research works focused on different issues in
That aspect, such as the increasing number of Sukuk issues through a range of years
Appeared tremendously increasing since the first issue by Malaysia. Sukuk issuance
Grew and spread in many of the Muslim country particularly the Middle East countries,
Such growth is driven according to the studies by Two Factors:
3.2 - Religious motive:
Where Muslim investors viewed it as an opportunity to invest
In a Shariahcompliant capital market product which was basically not in existence
And would definitely be an alternative of the conventional interest baring capital
Market products.
3.3 - Profit driven motives:
Issuers and investors are also driven by the financial gain that Sukuk generate to them.
Issuers would like to issue Sukuk to raise funding for their project and other economic
activities, while investors invest in Sukuk in order to generate a constant profit return through
the Sukuk tenure.

21
Chapter No # 4 Growth
4.1 Growth in terms of diversification in asset types and classes:
Other research work conducted focused on the necessity of choosing additional
Potential asset types and classes in order to meet the suitability of those asset types with
The market demand and acceptability, as well as the Shariah compliance. Sukuk ijarah
Was the first Shariahcompliant Sukuk issued, but in fact that would not constitute a
Competitive advantage in the future, therefore, more research was made to arrive at
more asset types to be potential ground for future Sukuk issues. As a result of such
Research activities, more other asset classes have been introduced and used to issue
Shariahcompliant Sukuk. At the present time there are 14 asset classes used for the
Sukuk issuance.
4.2 Growth in terms of monetary volume:
Research work which discussed the increase trends in the in volume of the issues in
A specific period of time and reasons for the rapid growth in local and international
Capital market, in the year 2000 the total of sovereign and corporate issuance for both
Domestic and international Sukuk was estimated to be U$ 336 billion, with 15% - 20%
annual rate of increase by the year 2007 the total value of issues reached U$ 88698
Billions (Numeric statistics, charts are provided).
4.3 Banking Perspectives:
In this section the research work conducted concentrated on the important role banks
Play right from the initial stages of the Sukuk issuance process by structuring,
Originating and marketing of the Sukuk. The research also stressed that Sukuk is one of
the instruments that can enhance Islamic inter-bank or short-term Islamic finance
Market development and is necessary vehicle in the development of Islamic Banking
and Finance Industry for its unique features and characteristics. Some writers raise
Some critical questions such as:
1- Profit driven objectives of the Sukuk issuing banks rather than the religious
Obligations which gives a negative connotation to the Sukuk concept.
2- Non replicability: Due to the differences in views of the Shariah boards of
Different Islamic banks in some modes of Sukuk issuances by those Islamic banks, made
it difficult for other Islamic banks to copy those product, and consequently that will
Negatively affect the development of such product in the Islamic capital market.
3- Other factor that slows product development in the Sukuk market is cost of the
Structuring. Islamic banks do away with complex Sukuk structures because they involve
High legal advisory cost and risk.
Forfurther improvement in the role of the Islamic banks in the enhancement And
development of the Sukuk market many writers put the following as key.

22
Chapter # 5 Factors
5.1 -Factors:-
1 Central banks should take initiatives in the standardization of modes of
Issuances of the different types of Sukuk.
2 Collaboration and coordination between central banks and AAOIFI, IFSB is
Important to strengthen the Islamic Capital Market.
3 Central banks borrowing through Sukuk is an important factor that
Contributes to the development of the Sukuk market.
3 Coordination and understanding between the Shariah boards of different Islamic banks
can create a better harmonization and existence of Standardization.
4 Shariah views, in particular controversial modes of Sukuk issues, can also contribute
To the Sukuk market development.
5.2 (c)Legal / Shariah Perspectives:
Legal issues:
Many researchers have been done in order to see how legislations both local and international
affect the Sukuk issues showing need for flexibility in legal structure to encourage more
issuance and investment. Such legal issues include taxation and ownership laws. Complex
Sukuk structures always rise challenging procedures which requires high cost legal
formalities. In addition, there are other legal issues such as the fact of most of the Sukuk
issued in Muslim countries are subject to the British law, and therefore, can cause a major
difficulties when the law is amended or when any problem related to the Sukuk asset arises,
because in many cases the Sukuk asset may not be located in Britain and that has a great
implication.
Shariah issues:
Most of the research on Sukuk have touched directly or indirectly some Shariah issues, and
that is for the following reasons: To find suitable Shariah views to those issues, to find
suitable and Shariahcompliant ways of Sukuk issuance, to find suitable Sukuk assets, to
bridge gaps and differences between different jurisdictions and schools of Shariah laws. For
these purposes several bodies were engaged in extensive research in that regard. The major
Shariah issues addressed are related to the Sukuk life span which include the following:
A. Process of issuing the Sukuk which includes selection of the underlined Assets, rating
process, position and role of the SPV and, pricing of the Sukuk.
B. Tradability of the Sukuk.
C. Determinant of the negotiability of the Sukuk
D. Redemption of the Sukuk.
E. Shariah rulings on the purchase undertake.

23
These researches show that there are lots of violations of Shariah principles which
Have to be strictly followed in order to come up a complete Shariahcompliant Sukuk,
Among these violations is none existence of the Sukuk assets, non suitability of the asset
For Sukuk issuance, lack of clear definition of the position of the SPV, violations in the
Rule of the tradability of the Sukuk where non tradable Sukuk is traded in the secondary
Market, guarantee of capital by repurchase undertaking.

24
Chapter # 6 Research Methodologies
6.1 The Research Methodologies:
As mentioned above, the sample of this evaluation is collected from three major Sources and
according to the nature of the research in the sample it is found that both of Quantitative and
qualitative methods were used, while some research adopted a single Method but most of the
research in the sample have used both quantitative and Qualitative methods.
6.2 Quantitative research:
Data collection on number of issues: Some research in the evaluation sample collected and
used the quantitative method by looking at the Sukuk issuance size, number, geographical
distribution, international, local, and currencies of issues, expected volume of issues.
6.3 Qualitative research:
On the other hand, the qualitative method was applied to collect and analyze data in regards
to the Sukuk issuance acceptability, Shariah and legal issues, types of contracts used, social
effects of the issue.
6.4 Fourth: Conceptualfocuses ofresearchpapers:
The research work included in this evaluation exercise which is based according to
The early classification of time (2000-2007), have also discussed several general issues
In regards to the Sukuk concept. Some of these issues are highlighted in the following:
1- Early research focused on the explanation of the basic concept of Islamic securitization
and relationship with the concept of Sukuk, the process and the parties involved as well as the
initial views of the scholars in that regard. Furthermore the research focused on innovation
and engineering of new ways, products, and tools.
Meanwhile some research focus on how to introduce new product, in fact on how to
Make conventional product into Shariahcompliant. For example, how to make
Conventional bonds into more Shariahcompliant product, such research came up with
Studies on how some Shariah based contracts such as Mudharabah, Musharakah, and
Istisnah etc., are applied for issuing Islamic bonds so that they become issues based on
certain Shariah based contracts and not debt based issues. There is other research in this
period Which focused on the factors that may be of great help in the process of developing
new products, these factors include government policy support which gives players more
freedom in choosing their business products and services.
2- Studies inside the middle targeted more at the Shariah and prison issues, despite the fact
that problems related to Shariah have been discussed inside the early stage of Sukuk
problems, however greater and more writings got here up particularly after the super
development in the Sukuk. Market where many merchandise have come into lifestyles and
extraordinary contracts have been used. on this stage research have in the main addressed
issues extensive, those include issues which includes the system concerned in the Sukuk

25
issuance, applicability of such Shariah based contracts in a number of the Sukuk issuance,
problems related to the character of relationship among the parties involved and, issues on the
identity and positions of the events concerned. Literature Review
3 -Recent studies targeted on standardization/ harmonization/globalization. The new trend
of latest studies focused more on how to create standardized Sukuk merchandise by
means of supplying standardized Shariah perspectives on problems. Some Shariah
problems related to Sukuk merchandise, the procedure of the issuance, nature of the
underlined assets and, other debatable issues in that regard. Research in this degree also
harassed importance of the position played by way of the critical banks, Shariah
regulatory establishments, as well as the auditing and advisory our bodies of the Islamic
financial institutions.
4 6.5 Sixth: Classifications ofresearchwork in terms of the languages
used:
Based on the available reading materials in the sample collected for this evaluation
Exercise most of research work done on Sukuk were in English language, the reason for
That was maybe because the concept of Sukuk was originally copied from the
conventional practice of bonds and securitization, and the initial efforts to implement the
concept and issue Sukuk was also done by non Arab Muslim countries such as Malaysia
and Pakistan. It is also observed that most of that work was short research papers such as
conference and seminar papers. There is also a lot of work done in the Arabic language.
The study also found that there are only very few books written on the topic of Sukuk.

26
Chapter # 7 General Structure of Sukuk
7.1 General Structure of Sukuk
Sukuk structure varies basedon the type of contract it’s basedon. But however, there are
three main parties involved in the Sukuk Arrangement: the originator of the Sukuk who is
the obligator, the issuer of the certificates who is the Special purpose vehicle (SPV) and
the investors or the subscribers who invest onthe Sukuk.
7.2 Figure (2-1)
1. The originator of Sukuk sells assets to be leasedto the issuer or the SPV.
2. The originator receives payment for the assets sold.
3. The issuer or the SPV leases back the assets to the originator of the Sukuk.
4. The SPV then receives rent payments from the originator under a specified term
Contract.
5. The funds will be collected by the SPV from the issuance of the Sukuk certificates.
6. The rent payments collected by the SPV from the originator are utilized to disburse
Distributions on the Sukuk certificates.
7. The investors (Islamic and conventional) both secure the Sukuk certificates.
8. The investors receive cash payments periodically by the distributions from the issuer
Or the SPV funded by rental payments on the leased assets.
7.3 Conclusion
Islamic finance has main prohibitions which distinguish it from its conventional
Counterpart. Those prohibitions are Riba/interest, Gharar/hazard and Qimar/gambling. The
Islamic contracts are categorized based on its function into three groups; transaction contracts,
Financing contracts, intermediation contracts and social welfare contracts. Moreover, Sukuk
as the Islamic finance alternative to conventional debt contracts origins for the financing
Contracts group and can be classified based on its type and structure. Sukuk can be classified
based on its type into pure Ijarah Sukuk, variable rate redeemable Sukuk, fixed-rate zero-coupon
Sukuk and hybrid Sukuk. Furthermore, it can be classified based on its structure into
Sukuk Al-Ijarah, Sukuk Al-Mudharabah, Sukuk Al-Musharakah, Sukuk Al-Salam and Sukuk Al-
Istisna’a. Moreover, the securitization of Sukuk is similar to the set-up process for
Conventional bonds.

27
7.4 Data Analysis and Methodology
This section describes the data used in this paper and the analysis used to test for the satisfaction
of the basic assumptions of the Delta-Normal VaR model used. Furthermore, it emphasizes the
three main VaR models, with more details given to the adopted Delta-Normal model.
7.5 Basic Data Description
The data used in this paper consist of sovereign and corporate Sukuk and bonds monthly prices
obtained from Bloomberg despite that weekly price are more accurate in representing the market
prices at which the portfolios position can be liquidated and this is due to restrictions imposed by
limited availability of sufficient daily time series in the case of Sukuk. And due to the fact that
Sukuk trading is restricted in primary market in most cases, this has limited the countries from
which Sukuk and bonds are selected.
The countries where the selected sovereign and corporate Sukuk and bonds comes from are
United Arab Emirates (Dubai) and Malaysia. Table (4-1) lists the issuer’s and security’s
descriptions.

28
The clean prices which are the trade price less the accrued interest between coupon
Payments (Fabozzi, 2002) are obtained from Bloomberg from 30th
of October 2009
or the first available date until 18th
of July or earliest available date, all in USD.
This period has been chosen as the period post-the highly volatile financial crisis
period which started in 2007. The reason for not including the highly volatile
period 2007-2008 is that extreme returns fat tails will occur which will not be
captured by the normal distribution that is a basic assumption in the chosen VaR
variance-covariance method (Hwang and Pedersen, 2004).
The returns are calculated for each Sukuk and bond using the log-normal formula
Where P1 and P2 are the last and new price respectively. This method is used in
Order to obtain stable data that statistically satisfies the chosen VaR method
(variance–covariance method) assumption of normal distribution.

29
Chapter # 8 Data Analysis
8.1 Data analysis:
In order to test that the data time series is stationary (has a long-run mean and
Variance that is not depending on time) and that its stable and normally distributed
a unit root test using the augmented dickey-fuller test (ADF) has been performed to
test for the presence of unite root to each security returns using E Views
programmed. The lengths of the lagged terms of the variables were determined by
Schwartz Bayesian Criterion (SBC).The ADF test states the following null
8.2 Hypothesis:
H0: Non stationary (has unit root)
H1:H0 false (stationary)
The absolute value of the ADF t-statistic and the probability value in each security
Tests led to reject the null hypothesis and accept that the data time series used in
this paper is stationary and hence has a long-run mean and variance that is not
depending on time.
8.3 Figures:
(4-1)- (4-16) illustrate the graph of the monthly returns of each security and
Its distribution, for three years period.

30
See appendix i-viii for ADF unit root test outputs

32
8.4 Conclusions:
Clean prices are obtained from Bloomberg from 30thof October 2009 or the first
Available date until 18thof July or earliest available date, all in USD and the returns of
each security are calculated using the Log-Normal formula. After performing the
augmented dickey-fuller test (ADF) to test for stationary and graphing the distribution
of the returns time series it can be concluded that the set of data time series used in
this paper after been converted into returns are stationary and is normally distributed,
and hence it is applicable to the variance-covariance VaR method implemented in this
paper.
This section discusses the concept of VaR and outlines the main VaR models and
Their advantages and drawbacks, and emphasizes the mathematical foundation and
the formulas that underline the adapted Delta-Normal model.
8.5 Methodology
Value-at-Risk has gained its importance as risk metric in portfolio management
after the wide adaption of “active” Portfolio management, i.e. actively adapt long-
short strategies, as the traditional risk measurements which tracks the portfolio
returns deviation from a benchmark ( e.g. tracking error ratio) become an
appropriate risk metric for the active portfolio management . Moreover, the
adoption of complex management strategies resulted in portfolio returns become
highly non-normal which made risk management needs more sophisticated risk
measurements tool. Hence VaR rose as a common risk metric.
8.6 Definition of VaR
VaR is a measurement for the worst loss expectedinthe value of the portfolio under
Certain confidence level and holding periodand under the normal market conditions.
VaR is based on two parameters:
1- The confidence level which depends on the riskattitude towards risk, as the more
risk averse the VaR user is the higher the confidence level is
2- The holding periodwhich is the riskhorizon?
8.7 VaR models

33
The three main VaR models are the Historical simulationmodel, the Monte Carlo
Simulationand the Delta-Normal model.
The Historical approachmodel: this model basic assumptionis that all future possible
variations have beenexperiencedbefore, andthat the simulateddistributionfrom the
historical datais identical to distributionover the holding periodor the riskhorizon.
The Historical approachhas the followingadvantages:
i. The model is easy to implement.
ii. The model short circuits the computation of the covariance matrix which simplifies
The method for portfolios with large number of securities.
iii. The model can be applied with the presence of fat tails and does not require any
Distribution assumptions.
The drawbacks of the Historical simulation model are:
1- The model assumes the historically simulated distribution can represent the future
Distributions.
2- The variation of the model is high compared to the other models.
3- The model needs large number of data in order to estimate the quartiles of the
Empirical distribution.
The Monte Carlo simulation model: this model has the same assumption as the Delta-
Normal model that the risk factor returns are normally distributed. While the main
difference between the two models is that the Monte Carlo simulation model
simulates the risk factors rather than analytically obtain such as in the Delta-Normal
model. This model is flexible and can be applied to any type of portfolio.
The Monte Carlo simulation model has number of advantages that makes it when accurately
Implementing it the most comprehensive model to measure market risk:
i. The model is flexible to incorporate time variations in the returns or the volatility of
the returns, and can be implemented in presence of fat tails and incorporate extreme
scenarios.
ii. The model can be implemented in complex portfolios which consist of derivatives, as
the model can incorporate the passage of time which creates structural changes in the
portfolio.
However the main disadvantages of the Monte Carlo simulation model are:
i. The computational complexity of the model and the cost of systems needed to
Implement the model.
ii. The model relies on specific stochastic processes for the risk factors, which can lead
To inaccurate results when the stochastic processes followed are wrong.
iii. The Delta-Normal VaR model: the covariance matrix is the central risk factor in this
Model hence it’s also called variance-covariance model. The basic assumption in this
Model is that the risk factor returns are normally distributed and that their joint
Distribution is multivariate normal. This assumption allows us to determine the worst
5 % or 1 % that lie on the returns curve, under the confidence level. Moreover, this
Model assumes that the variance-covariance metrics contains all the information of
The market risks relevant to the portfolio.
8.8 Mathematicalfoundation for the Delta-NormalVaR measurement

34
This section will derive a general formula for VaR for a linear portfolio with normally
distributed returns without mapping the portfolio to its different risk factors.
X ~i.i.d N (μ, ơ2) EQ. 1
Where X is the portfolio returns, i.e. is the discounted h-day return, μ is the expected
return and ơ2 is the variance.
To obtain a formula for the α quintile returns, i.e. the returns where
P (X xα) = α P (X xα) = P ( . ) = (Z )
Where Z ~ N (0.1), P is the value of the portfolio when the VaR is measured. Hence:
P ( Z ) = α and
Since:
p (z Ф -1(α) ) = α, it follows that:
= Ф -1(α) EQ. 3
Where Ф is the function of the standard normal distribution and since Ф -1(α) = - Ф -
1(1-α) (1.3), Substituting (1.3) into (1.2) will give:
VaRα = Ф -1(1-α)ơ - μ EQ. 4
Where (1.4) is VaR formula for portfolio with an i.i.d normal return. We can even
write (1.4) as :
VaRh,α = Ф -1(1-α)ơh - μ EQ. 5
Eq. (1.5) is a simple formula for 100α % h-day VaR as percentage of the value of the
portfolio with certain expectation (μh ) and standard deviation (ơh ). In order to obtain VaR as
value we multiply the VaR percentage with the value of the portfolio to get:
VaRh,α = (Ф -1(1-α)ơh - μ) Pt EQ. 6
VaR in the Delta-Normal method depends on the variance of the portfolio which can
be calculated using the formula:
Ơp = W Σ W’ EQ. 7
Where W is the vector of weights for different securities in the portfolio, Σ is the
variance-covariance matrix of the returns of each portfolio, W’ is the transposed vector of
weights for the portfolio securities.
Further, the portfolio VaR can be calculated using the formula:
VaR = α P √( W Σ W’) EQ. 8
Where α is the standard normal deviation (e.g., 1.645 for 95 % confidence level), μp
is the average returns of the portfolio and P is the initial portfolio value.
The Delta-Normal model has two approaches in estimating the time series and
correlations. The first is the standard equally weighted moving averages approaches. The
second approaches are the exponentially weighted moving averages approaches. The equally
weighted moving averages are applicable for long-term as VaR estimates represent the
average of the volatility of the sample over the time horizon. While the exponentially
weighted moving averages VaR estimates represents the current market risk rather than the
average of the market volatility.
The standard deviation in the equally weighted moving averages and the
Exponentially weighted moving averages are calculated by formula (1.9) and (1.10)
Respectively:
Ơt = √[ 1/(k-1) t-1 2 ] EQ. 9
Ơt = √ [ (1-λ) ] EQ. 10
Where k is number of days in the observation, Ơt is the estimated standard deviation
of the portfolio in day t, μt is the mean change in the portfolio value, x is the change in the
portfolio value in time t, θ is equal to λt-s-1, where λ is decay factor
The Delta-Normal method main advantages can be summarized in the following points:

35
1 This model is tractable
2 This model is computationally fast with large number assets
3 This easily enables analysis by easily obtain the marginal and incremental from the VaR
computation.
However, the Delta-Normal has two main drawbacks:
1 This model is only applicable for portfolios with normally distributed returns. This
Assumption creates bias problem when calculating VaR for portfolios with fat tails
exist in its returns distribution. However, there is no much bias when choosing 95 %
Confidence level.
2 This model is only applicable for linear portfolios which make the Delta-Normal
model not applicable for complex portfolios, where asymmetries tend to disappear.
However, the model can be generalized to another parametric forms such as the
Student-t distribution
8.9 VaR Model Building Process
Building VaR model can be defined into two main steps: I. Identification step: in this step the
portfolio, its risk factors and the model basic parameters are identified.
ii. VaR calculation step: in this step the portfolio is mapped to its risk factors and
The risk factors are evaluated over the risk horizon, and VaR estimates are obtained.
8.10 Conclusion
There are three main methods to estimate VaR which are the Historical simulation
model, Monte Carlo simulation model and the Delta-Normal model. Each of these models
has its advantages and drawbacks. However, the Monte Carlo simulation model is most
Comprehensive model when it’s used accurately. The paper implements the standard equally
Weighted moving averages approach which applicable for the chosen three years time
Horizon in a Delta-Normal model which is fairly accurate to measure the market risk of
Simple linear portfolios and is simple to implement.
Chapter 9

36
9.1 Application to Sukuk and Conventional Bonds
Introduction
This chapter contains VaR applicationto Sukuk and conventional bonds and presents
the estimationresults obtainedfrom the Delta-Normal method. And finallypresents
Evaluation and discussiononthe results.
9.2 Defining the portfolio and identifying its risk factors
Three equally weighted a different hypothetical portfolio which gives different
Investment alternatives are created with value of 8 USD million. The first portfolio is pure
Conventional bond portfolio, whereas the second portfolio is pure Sukuk portfolio and the
Third is a mixed portfolio that consists of both Sukuk and conventional bonds with equal
Portions. The portfolios consist of sovereign and corporate securities issued by the same
issuer except for the case of the Malaysian corporate Sukuk and conventional bond were due
to restriction of availability of same issuer for both Sukuk and conventional bonds, Sukuk and
Conventional bonds from two different issuers within the same industry and with the same
Credit rating has been selected. The application of this paper is to measure the VaR of fixed
Income portfolios if it’s managed “passively”, i.e. tracking the returns of a benchmark. The
reason for choosing passive bond portfolio management strategy is to eliminate the portfolio
Management strategies that exist in the conventional bond market rather than Sukuk market in
order to measure and compare the risk of the constructed portfolios. The risk factor in this
Model is the covariance’s matrices of the returns of the securities of the portfolios.
9.3 Table (5.1)

38
9.4 Setting the basic parameters for the model
The chosenholding periodis 3 years and the confidence level is 95% to determine the
Capital under risk under this confidence level. The choice of the confidence level is set to
avoid underestimatingor overestimatingthe VaR estimates, as if the historical series
exhibits heavy tails which is the case in the row data of the prices usedin this paper
before usingthe log-normal formulato calculate normallydistributedreturns, then
computingVaR using a normal distributionwill underestimate VaR at higher confidence
levels such as 99% and over estimate VaR at low confidence levels. The choice of the
holding perioddepends on applicationcontext.
9.5 Value-at-Risk calculation
In able to calculate the VaR the correlations andcovariance’s among the monthly
Returns of securities(Sukuk and conventional bonds) in the mixed portfolio, pure bond
Portfolioand the pure Sukuk portfolioare formedandmapped4 to the portfolio position5.
The Estimates results of the Delta-Normal VaR methodfor the three portfolios are
reportedin
9.6 Table (5-4)
9.7 Discussion
The Delta-Normal methodshowedthat for the mixed Sukuk and (conventional bonds)
Portfoliothe market loss of the portfolio value held for three years cannot exceed37.8 %
of the portfoliovalue (as of mid of July 2012) with95 % certainty. While the
correspondingFigure for the pure bond portfoliois 56.9 % with 95 % certainty. Whereas,
for the pure Sukuk portfolioits 76.8 % with95 % certainty. The reductioninVaR in the
mixed (Sukuk and conventional bonds) portfolio is 39 % and 19.1 % comparedto the
pure Sukuk and pure bond portfoliosVaR’s respectively. This reductioninthe market
riskof the portfoliois mainlyexplained by the low correlationbetween Sukuk and
conventional bonds during the holding Period. The highest correlationcoefficient
between Sukuk and conventional bonds in the mixed portfoliois 26.4 % betweenDubai
Govt international bondand PETRONAS global Sukuk. Whilst, the correlationbetween
Dubai DOF Sukuk and Malaysia Sukuk global and betweenDubai DOF Sukuk and
Malaysian government bond are -31 % and -43.5 % respectively. And the correlation
between Tamweel funding Sukuk and Petroliam national berhd is 4.5 %.These correlation
figures indicate that Sukuk and conventional bonds prices have different behavior in the
secondarymarket. Thus, investing in a portfolio that is mixture between Sukuk and

39
conventional bonds reduces portfolio market riskthroughdiversificationgainedfrom
adding two different financial instruments to aportfolio. The diversificationbenefits
gained from investing in Sukuk along with the conventional bonds are independent from
the rate of returnof the portfolio whichledto reducing the portfolioriskwithout
compromisingthe rate of return. This result supports Ariff and Safari (2012)resultson
their study on the yield of Sukuk and conventional bonds. And in line with Cakir and
Raei (2007)results on Sukuk diversificationbenefits. Onthe other hand the pure Sukuk
portfolio market riskis significantlyhigh as its 19.9 % higher than the pure bond portfolio
market risk. The high VaR estimate for the pure Sukuk portfolioindicates that Sukuk
invested in the pure Sukuk portfolio are riskier thanthe conventional bonds investedin
the pure bond portfolio. This result is parallel with that Zaidi (2006) concluded. The
followingfactors are identifiedto increases Sukukrisk comparedto conventional bonds.
9.8 Market risk:
Some types of Sukuk structures are fixed-rate based. Some of Sukuk al-Ijarah which has
The secondlarger global issuance with 3,991 USD millionin the secondquarter of year
2012 (Zawya, 2012), are fixed-rate basedand benchmarked to either Londoninterbank
offer rates (LIBOR) or Karachi interbank offer rates (KIBOR). This will expose Sukuk to
interest rate riskas the Sukuk prices will fall when interest rates rise. Moreover, Sukuk
holders will face. Risk of opportunitycost that will be createdby losingthe opportunity
of investing at the new higher rates. The reasonwhy Sukuk interest rate riskwill be
higher than the conventional bonds interest rate riskis the illiquidityof Sukuk due to the
limitedsize of Sukuk secondary market comparedto conventional bonds. Moreover,
other types Sukuk suchas Sukuk al- Murabaha which is the largest issued Sukuk globally
(Zawya, 2012) is not tradedin the Second market because debt is untradeable according
to Shariah principles. This illiquidity creates amajor obstacle for Sukuk portfolio
managers in adapting active portfolio management strategies that conventional bonds
portfolio managers implement to protect the portfolio returns from interest rate changes.
9.9 Credit risk:
Credit riskis the probabilityof default or delay in settlementswhichmakes the debt or
The asset irrecoverable. Sukuk structure is basedon the basic Islamic finance principle of
Profit andlosingsharing (PLS). This makes credit riskof Sukuk higher than its
conventional counterpart. Moreover, the reschedulingof debt is prohibitedin Shariah
principles due to the basic prohibitionof interest. Further, the absence of value of money
in Islamic finance creates amajor riskfor Sukuk investors whom might face debt
reschedulingat events of default without mark-up added to compensate them.
9.10 Shariah compliance risk:
Shariah compliance riskrises from the probabilityof the asset losingits value as a
Result of issuer breaching Shariah principle ina later stage of issuing the Sukuk . Sukuk
al-Ijarah can be exposedto this type risk, as the fixed-rate basedsettlements paidby the
obligor to the issuer (SPV) and passed to the investors are fixed to the LIBOR rather than
being benchmarked to the returns from the underlying asset which makes distinguishing
between conventional bonds and Sukuk al-Ijarah debatable from Shariah perspective.
This issue rises inlarger scale under the present of Shariah opinions conflict from country
to another.

40
9.11 Correlation betweenSukuk:
Correlationbetween Sukuk selectedinthis paper has been identifiedto be significantly
Higher than the correlationbetweenconventional bonds. These high correlations between
Sukuk result ina higher risk involved in investing in a pure Sukuk portfolio.
Figures (5-1)and (5-2) plots the movements of the prices of Sukuk and conventional
bonds respectively. Figure(5-1) shows that that Sukuk prices movement inthe secondary
market are highly correlatedespeciallyinthe period2009-2010. Although, Tamweel
Funding corporate Sukuk (Dubai) shows lower correlationwithother Sukuk in the
Portfolio. Figure (5-2) shows that:
The conventional bonds prices followeddifferent behavior in the secondarymarket.
However, there were high correlations observedbetweenEmirates airlines corporate
bonds (Dubai) and government of Dubai sovereignbonds in the period2009-mid2010.
This can be explained by the fact that Emirates airline is part of Dubai holding which is
owned by the government of Dubai.
A main reasonfor high correlationbetweenSukuk is the restrictioninsectors Sukuk
Are allowed to finance accordingto Shariah principles, beside that Sukuk should be
backed by real investments. Hence the diversificationamongsectorsin Sukuk market is
limitedcomparedto conventional bonds market.
The unique riskfactors Sukuk inherit beside the other riskfactors Sukuk share with
Conventional bonds along with the absence of riskmanagement derivatives in Sukuk
market results in Sukuk investors being exposedto all types of risks without having risk
management tools that exist in the conventional finance market. These provoke investing
in global Sukuk portfolioto inherit higher riskthan in investing in global conventional
bond portfolio.

41
9.12 Findings and recommendations of these researchpapers:
The collective and ordinary findings of the studies work blanketed in this evaluation examine is
understood thru the conclusions of these works that Sukuk has became a very essential Islamic
capital marketplace device over the last decade and has been commonplace now not simplest by
way of Muslim traders but also by using many non Muslim buyers in many parts of the sector,
that was due to the precise characteristics Sukuk has which enabled it to offer a aggressive
advantages over other instruments inside the Islamic capital market compared to the traditional
bonds Sukuk has additionally a first rate competitive benefit within the capital marketplace.
Popularity and boom of the Sukuk market is expected to preserve which necessitates a continuous
development in many of its components. Therefore, those studies came up with a few important
findings and counseled wide variety of recommendations which can be summarized within the
following: role played through the central banks, Shariah regulatory establishments, in addition to
the auditing and advisory bodies of the Islamic financial establishments.
Findings:
(A) Competitive advantages: Issues of Sukuk especially to Islamic capital market
Players give competitive advantages, since Islamic capital market players cannot issue
conventional bonds; the alternative is Shariah compliant bond which is Sukuk.
(B) Sukuk is a very important tool for the mobilization of the Islamic funds, since a
Big amount of the Islamic funds is inactive in the economy.
(C) Sukuk issuance has greatly contributed in the enhancement of more
Infrastructural developments in many of the Muslim countries by issuing Sukuk that provide
capital for mega projects.
(D) By Sukuk issuance a great achievement has been made in meeting demands of
The Muslim communities especially those living in none Islamic countries where the banking
system and the capital market instruments operate entirely in a pure conventional Riba-base a
system.

42
9.13 Recommendations:
1- There’s first rate need for information inside the discipline of Islamic finance and consequently,
increased and continuous effort in teaching and schooling more human assets by means of
establishing extra instructional and education facilities may be a key factor inside the know-how
and development of the Islamic capital market instrument together with Sukuk.
2- The need for innovation and development of new Shariah compliant products in
The Islamic capital market especially the structuring of more Shariah compliant
Sukuk products is a very important factor the enhancement of the local and global
Market.
3- Role of the Shariah board of advisers should be viewed as vital in decision
Making in regards to a particular product. Therefore, the process of selecting a
Member of the Shariah board should be purely based on academic outstanding,
Knowledge of Shariah, experience in the field and, contribution of the member
to insure consideration of the right Shariah opinion on that matter and
Consequently take the right decision.
4- The opinion given by the Shariah board of advisers should be the major
Consideration when it comes to organizational decision making on the
Particular matter of concern.
5- When rating Sukuk, the issue of Shariah compliance in all the process has to be
One of the major issues rather than looking at other credit worthiness of the
Sukuk issuance.
6- To ensure continuous and efficient growth of the Islamic finance industry,
Move forward and capitalize on the enormous growth potentials, there should
be better coordination to address the issue of Shariah harmonization and
Creation of international Sukuk fund.
7- Transparency in knowledge sharing among different Islamic financial
Institutions is one of the factors that can assist in the creation of better
Understanding and harmonization in product development.
8- Development of the Sukuk market in any region depends on the political and
Legal flexibility towards Sukuk issues. Therefore, government initiatives in this
Regard especially by easing laws related to ownership and taxation is very important.

43
9.14 Conclusionand Recommendations:
Distinguishing Sukuk from its conventional counterparts as different types of Investment
instruments has been a debatable issue among literature. This paper has outlinedthe
concept of Islamic finance from which Sukuk originfrom, and reviewed the literature
done ondistinguishing Sukuk from conventional bonds and evaluating Sukuk impact on
investment returns. Moreover, the paper introducedcorporatebonds to the portfolio in
order to evaluate Sukuk impact ona riskier portfoliothanone that onlyconsist of
sovereign Sukuk/bonds. The paper also succeededinfillinga gap by evaluating the risk
of pure Sukuk portfolioandcompares it to the riskof a pure conventional bond portfolio
in order to appraise Sukuk instruments as an investment alternative to conventional
bonds. Results of this paper shows evidence that Sukuk provides diversificationbenefits
gained from their different price behavior in the secondarymarket to a conventional bond
portfolio bysignificantlyreducingthe riskof the portfolio. This result is consistent with
Cakir and Raei (2007). Moreover, the paper shows that Sukuk inherits higher market and
credit riskthan conventional bonds due to restrictions Shariah principles impose on
Sukuk riskmanagement. Moreover Sukuk inherits additional riskelements arise from the
high correlationbetween Sukuk comparedto correlationbetweenconventional bonds.
Another riskelement associatedwith Sukuk is Shariah compliancyriskwhich doesn’t
exist in Conventional bonds. These riskfactors place Sukuk competitivenesswith
conventional bonds as an investment alternative in the global market in a major
disadvantage unless the global Sukuk market sees an major institutional reform that
resolves the conflictof Shariah scholar’s opinions which exposes Sukuk to the riskof
Shariah compliancy. Moreover, Sukuk sector shouldalso developfinancial derivatives
such as Islamic embedded options and floatingto fixed rates swaps of Sukuk that are
Shariah compliant via Islamic financial Engineering development. These reforms and
developments will enhance the competitiveness of Sukuk, and hence will foster the rapid
growth of global Sukuk market. Further will shift Sukuk global market from quantity
growth to quality enhancements. Through reading the much possible number of
available research, this evaluation Work found that the trends of the research
conducted have generally addressed most of the necessary issues in regards to the
Sukuk concept and issues which include economic, Shariah and legal issues. It is also
observed that the later research have addressed most the questions raised by the earlier
research, especially the recommendations given by the earlier research have positively
guided later researchers in finding solutions to many of the problems raised.
Nevertheless, there are some issues which relate to Islamic Social responsibilities
which have not been critically addressed. In addition, there are other fundamental
issues which have been raised by some research and still need to be solved and made
clear. These issues include the following:
1- Initial process of issuing Sukuk which involve several contacts such as :
A. Role of the corporate banks, i.e. wakeel/owner, who also make
Profit out of the Sukuk sells. The Shariah ruling which governs the position
Of a wakeel need to be clarified in order to determine the scope of the
Wakeel roles.
B. Process of pricing the Sukuk, i.e. by way of bidding.
C. Appointment and position of.
D. The Repurchase undertaking.
More research is needed in these areas to clearly, address and find the appropriate
Shariah rulings on each and every one of these issues.

44
2- Aim of the Shariah is the welfare of the society; we observe that despite the
Tremendous amount of money raised and the many investment involved are not meant
For the well being of the majority poor people, and no serious plan was made to solve or
Even address the issue of poverty, the money is rather raised in most cases for luxury
Purposes. Therefore, it is recommended that these issues should be given more
Consideration.
3- Most of the research mainly addresses issues of how to make the existing
Products in the conventional capital market into Shariah compliant by either amending
Some of their features or putting them under some underlined Shariah based contracts
Such as Musharakah, Ijarah, Istisnah and so forth, which in some cases raised questions?
On their suitability and validity. On the other hand, compared to the replication efforts
Made, less research and efforts were made on how to innovate and develop purely
Shariah based products which are supposed to be the main concern of any research made
On product innovation and development.

45
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