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CHAPTER - 2

Financial Market and Islamic finance

2.1. Definition of Financial Markets

At the very outset, the answer to the most fundamental question about the

financial markets: “what are the financial markets for?” “What is the raison d’être?” 1

has to be sought. The raison d’être for a financial market is about matching and

transferring funds from those who want funds (borrowers) with those who have it

(lenders) in economy.2 Different dictionaries have given different meanings of financial

market. The Oxford dictionary of Economics terms Financial Markets as “The markets in

which financial assets are traded. These include stock exchanges for trading company

shares and government debt, the money market for trading short-term loans, the

foreign exchange market for trading currencies, and a number of specialized markets

trading financial derivatives.”3 It has been referred in “Money, Banking, International

Trade and Public Finance” as “the institutional arrangements for dealings in financial

assets credit instruments of different types such as currency, cheques, bank deposits,

bill, bond etc.”4 Normally, the expression ‘financial market’ is used in reference to a

market wherein some sort of financial product is being traded. In the modern times, the

financial market is a very complex part of the modern business world. There are a large

1 Stephen Valdez, An Introduction to Global Financial Markets (New York: Palgrave Macmillan, 2007) p.3. 2 Mohammed Obaidullah, Islamic financial Markets: Towards Greater Ethics and Efficiency (New Delhi: Genuine Publications & Media (Pvt. Ltd.), 2004) p.1. 3 John Black, A Dictionary of Economic (New Delhi: Oxford University Press, 2002) p.175. 4 D. M. Mithani, Money, Banking, International Trade and Public Finance (Delhi: Mimalaya Publishing House, 2000) p.214.

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number of markets and many different types of financial products and securities issued

by financial intermediary bodies within these markets.

2.2. Classification of Financial Markets

There are many way to categorize the type of financial market. However the

markets have been classified by different aspects as following.

2.2.1. Debt and Equity Markets

This category divides financial market by the claim nature of financial

instruments which are bought and sold in financial market. Debt market is market for

trading debt instruments and equity market is the financial market for trading equity

instrument.

Financial instruments can be grouped by the type of claim that the holder has on

the issuer. When the claim is for a fixed amount, the financial instrument is named as

debt instrument. The bonds (bills), negotiable certificates of deposit, and treasury bonds

are examples of debt instruments requiring fixed payments. In contrary, equity

instrument the issuer of the financial instrument obligates to pay the holder an amount

based on earnings, after the holders of debt instruments have been paid. Common stock

is an example of an equity instrument.5

A debt instrument is a written assurance to repay a debt. A debt instrument can

be promissory note, bill of exchange, bond or other such instrument. In most cases a

debt instrument can be sold, traded, or otherwise used as a form of currency or barter,

with the debt owed to the debt instrument's current holder.

5 Frank J. Fabozzi, The handbook of financial instruments (New Jersey: John Wiley and Sons, 2002) pp.2-3.

26

Short-term debt instruments are exchanged in the money markets. These

instruments include short-term bonds (bills), negotiable certificates of deposit,

commercial paper, and repurchase agreements.

Long-term debt instruments are exchanged in the capital market. These

instruments include long-term government and corporate bonds (bonds), residential6,

commercial, and farm mortgages7, and commercial and consumer loans.8

2.2.2. Money and Capital Markets

In some aspect the financial markets can be divided by the maturity of financial

products. The money market is a market of short-term financial instruments with its

maturities for generally one year or less. Opposite with money market, capital market is

the market for long-term financial instruments. It alludes to all the facilities and the

financial intermediaries who arrange borrowing and lending of medium-term and long-

term funds9

Money markets or credit markets are the markets for debt securities with their

maturities for short period of time. These include Treasury bills, banker’ acceptances,

commercial paper, and negotiable certificates of deposit issued by government and

private institutions. The characteristic of financial instruments in money markets are

6 Residential Mortgage is a mortgage loan for residential property. The US residential mortgage market is enormous, with trillions of dollars of mortgage debt outstanding. Much of this residential mortgage debt has been securitized and sold to investors in the form of mortgage-backed securities. 7 Commercial Mortgage is a mortgage which is secured by real estate which is used by a business. Also, the proceeds of a commercial mortgage must be used for business purposes. Many commercial mortgage lenders require a minimum loan size, often half a million dollars or more. A commercial mortgage may be secured by an on-going business, a building or raw land. A commercial mortgage may be a first mortgage or a refinance of an existing mortgage. When a commercial mortgage is traded or sold on the open market it is called a commercial mortgage security 8 Syed B. Hussain, ed, Encyclopedia of Capitalism, v.1 (New York: Facts On File, Inc., 2004) p. 194. 9 K.P.M. Sundharam, Money, Banking, Trade and Finance (New Delhi: Sultan Chand & Son, 2000) p. 1.197.

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highly liquid feature and a relatively low default risk. In contrary, financial instruments

traded in capital markets are long-term securities issued by government and

corporations which are characterized by relatively high default and market risk10.

However, they also carry high yield in compensation for the higher risks.11

2.2.3. Primary and Secondary Markets

Financial markets may be convenient categorized by seasonal feature of financial

markets. It is divided into primary and secondary markets. Primary market represents

the market whose financial products and securities are first offered to public. On the

other hand, a secondary market refers to where financial products and securities are

resale and trade after first offered. Thus financial products and securities can be sold

only one time in a primary market after that all afterward transactions take place in

secondary markets.12

2.2.4. Cash and Derivative Markets

Cash market or sport market is the market in which a financial asset trades for

immediate delivery. The Derivatives Market is a financial market where trade of

derivatives takes place. Financial Derivative is a kind of securities whose price is derived

from the underlying assets.13 Value of derivatives is determined by the Variation in the

10 Market Risk is the risk that the value of an investment will decrease due to moves in market factors. The four standard market risk factors are: Equity risk; the risk that stock prices will change, Interest rate risk; the risk that interest rates will change, Currency risk; the risk that foreign exchange rates will change, Commodity risk; the risk that commodity prices will change.

11 Jae K. Shim and Michael Constas, Encyclopedic Dictionary of International Finance and Banking (New York: St. Lucie Press, 2001) p.103. 12 Edwin j. Elton and Martin j. Gruber, Modern Portfolio Theory and Investment Analysis (Singapore: John Wiley & Sons (Asia) Pte. Ltd., 2005) p.32. 13 Underlying Assets: Financial derivatives are securities whose value depends on another security or some benchmark, such as a particular interest rate or the value of a financial index at a specified time The

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underlying assets. These underlying assets of derivative product can be commonly

stocks, bonds, currencies, interest rates, commodities and market indices. As Derivatives

are agreement between two or more parties, thus anything like weather data or amount

of rain can also be used as underlying assets.14 Generally, the Derivatives instruments

can be classified into sub- category as Future Contracts, Forward Contracts, Options,

Swaps and Credit Derivatives.15

Derivative instruments are used as important financial management tools to

increase investment returns and to manage any risks relative to interest rates, exchange

rates, and financial instrument.16

2.2.5. The Foreign Exchange Market

The foreign exchange market (FX or Forex in short) is where foreign currency

trading takes place. It is where banks and other official institutions facilitate the buying

and selling of foreign currencies. This includes sport markets with immediate delivery

and futures markets with delivery on future dates at pre-arranged price.17 The foreign

exchange market plays an indispensable role of providing the necessary tool for making

value of a derivative security depends on the value of its underlying financial asset The underlying asset may be common stock, bonds, stock indices, commodities, foreign currency or even other derivatives such as futures contracts or swaps. 14 Weather Derivatives: financial instruments that used as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. It used to hedge against the risk of weather-related losses. The investor who sells a weather derivative agrees to bear this risk for a premium. If nothing happens, the investor makes a profit. However, if the weather turns bad, then the company who buys the derivative claims the agreed amount. Farmers can use weather derivatives to hedge against poor harvests caused by drought or frost. Currently, the largest users group of weather derivatives is primarily energy companies and energy-related businesses. 15 Brian A. Eales and Moorad Choudhry, Derivative Instruments: A Guide to Theory and Practice (Oxford: Butterworth- Heinemann, 2003) p.1. 16 Burton S. Kaliski, ed, Encyclopedia of Business and Finance (New York: Macmillan Reference USA, 2001) p.235. 17 John Black, A Dictionary of Economics (UK: Oxford University Press, 2002) p.183.

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payments across borders. It transfers funds and purchasing power from one currency to

another. The foreign exchange market is considered the largest financial market in the

world with an approximately 1.6 trillion US dollars average daily. The market is

distinguished from the commodity and equity markets because it is no physical

marketplace in any one country. It is an over-the- counter market and truly a 24-hour

global trading system.18

Trading in foreign exchange is preformed using the telephone network and

electronic screens. Sometime trading is performed through automated electronic

dealing systems which enable users to quote prices and to deal and exchange

settlement details with other users on screen. Participants in foreign markets do not

exchange physical money coins and notes but they exchange the ownership of bank

deposits denominated in different currencies. Tourist who makes a physical exchange of

local currency for foreign currency is also a participant in the market. However, foreign

exchange rates in the markets are driven by institutional trading. Because of almost all

transactions in foreign exchange markets being dealt by financial institutions, less than

10 percent of daily turnover of the market is made by banks and their costumers which

generally is a tangible international payment. London, New York, and Tokyo are major

centers of trading of foreign exchange.19

2.3. Financial Markets: Overview

Financial system is an indispensable part of economic system. It is a sub-field of

economic system which consists of financial markets, financial institutions, and financial

18 Shani Shamah, A Foreign Exchange Primer (England: John Wiley & Sons Ltd, 2003) p.1. 19 Dean Paxson and Douglas Wood, eds, The Blackwell Encyclopedic Dictionary of Finance (USA: Blackwell Publishers Inc., 1998) p.168.

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instruments. The fundamental function of the financial system is to transit financial

funds between the lenders and borrowers. The lenders are those who lack productive

investment opportunities but possess financial wealth or are net savers. Borrowers are

those who lack fund to undertake their productive investment opportunities or net

spending. Then financial institutions act as channel of fund flow between the two

ends.20

Financial markets throughout the world have been undergoing significant

changes in the post war period. Since last two decades, global financial markets have

been fast changing. Driven by an interacting process between financial innovation and

liberalization process; restrict regulations have been taken away. New financial products

have been introduced to financial markets and boundaries between financial

intermediaries have been removed. With the new financial innovations, the costs of

financial intermediation have fallen and a number of financial assets are available for

end-user at minimum cost. Risk management tools have become an important tool of

success of any business firms. 21

Since the beginning of 1980s, the structure and function of financial market in

many industrialised countries have undergone change by financial deregulations and

innovations. These change influenced globalization process of financial markets,

changing of market-oriented financial structure, growth of investment banking,

narrowing of functional banks in different category, and evolution of regional trade

20 Syed B. Hussain, ed, Encyclopedia of Capitalism, v.1 (New York: Facts On File, Inc., 2004) p.294. 21 Risk Management is a financial term, defined as a scientific approach to dealing with pure risks by expecting possible accidental losses and designing and implementing procedures that minimize the occurrence of loss or the financial impact of the losses that do occur.

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blocks such as Asia-Pacific, North-America, and the rest of the world. These changes

have deep impact on the shape of global financial market. 22

2.4. Significance of Financial Markets

The role of financial markets toward economy can be analyzed by a number of

criterions. The function of financial markets is one of criterions used to describe it role.

Some views are as follow:

According to D. M. Mithani (2000), the financial markets offer four basic

functions. First, they provide facility for creation and allocation of credit and liquidity.

Second, they serve as intermediaries in the process of mobilization of savings in the

economy. Third, they provide financial convenience to the people. Last, they promote

the process of economic development through a more balanced regional and sectoral

distribution of investible funds.23

According to Frank J. Fabozzi (2008), financial markets provide three major

economic functions. The first major function of the markets is to determine the prices at

which financial asset are traded. This process is known as ‘‘price discovery process.’’.

The integration and interaction of buyers and sellers in a financial market determines

the price of the trade asset. In other word, they determine the required return on

financial instruments. The price discovery is so important for the efficient working of the

economy that it is imperative that the integrity of prices be protected.24

22 G.S. Batra, Globalisation of Financial Markets (New Delhi: Deep & Deep Publications PVT. LTD,2004) p.39. 23 D. M. Mithani, N.4, p.214. 24 Frank J. Fabozzi, Foundations of Financial Markets and Institutions (New Jersey: Pearson Education, 2002) p.5.

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The second economic function of financial markets is to offer a mechanism for an

investor to sell financial assets. Which means that the market provides “liquidity” to

holder of financial assets. Without financial markets the investors get nowhere to sell

financial assets. Then, there were not liquidity; the holder of financial assets would be

forced to hold the financial assets until its maturity.

The third economic function of a financial market is that it reduces the cost of

transaction which consists of search cost and information costs. 25

Other view was given by Marc Levinson (2006). According to him even financial

markets are divided into different forms. But all of them provide the same basic

functions as Price setting, Asset valuation, Arbitrage, Raising capital, Commercial

transactions, Risk management. 26

2.5. Origins of Financial Market

The modern securities market has its origin from medieval Italy where the

various city states such as Venice, Genoa, and Florence became commercial centers of

trade between East and West. With the growth of commercial activity of these city

states, various types of financial arrangements were developed to solve financial needs

of their business. Deposit banking, marine insurance, bill of exchange, joint stock

companies, and transferable securities were created in response to the financial needs

of borrowers and investors, and to the requirement of making receipts payments over

far distances.

The particular events that can be considered as the beginning of the financial

market was the issue of promissory note of Venice city state in 1171-1172. With the

25 Frank J. Fabozzi, The Handbook of Finance: v.1, Financial Market and instruments (New Jersey: John Wiley and Sons, 2008) p.6. 26 Marc Levinson, Guide to Financial Markets (London: Profile Books Ltd, 2006) pp.2-3.

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emergence of war at that time, Venice city required additional money to support its war

fare. However, in preference to raise additional amounts by increasing taxation as

traditional means which would damage its economy, the Venetian authorities choose to

raise its additional fund by borrowing from their own wealthy citizens. In return, they

were promised to be paid interest on the amount compulsorily borrowed until they

could repay. These promissory notes were in form of interest-bearing bonds with no

definite date of repayment.

Without definite date of repayment, the bonds began to be sold by holders in

need of money and bought by others seeking a regular income. As bonds of Venice

never failed to pay the promissory interest, during 1262 to 1379, these transferable

securities gradually acquired acceptance as secure and tradable financial equipment not

only in Venice but throughout Europe. The success of Venice was followed by other

Italian city states such as Genoa, Sienna, and Florence then the securities market take its

global cheap27

2.6. Money Markets

The term “Money market”, mentions to the network of corporations, financial

institutions, investors and government which deal with the short-term capital. Money

markets are important part of the financial system. It provides liquidity to the system

with relatively short maturity and low interest rates financial instruments. With the

diverse range of financial assets that can be traded within the market. The market

provides wide range of opportunities and funding to users. It provides working capital

27 Ranalb C. Michie, The Global Securities Market: A History (Oxford: Oxford University Press, 2006) pp.17-18.

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for industrial and commercial corporate institutions. Moreover, the well functioning

market also facilitates the smooth running of the banking industry as will. 28

Unto the 1980s the financial markets almost were centered on commercial

banks. Most of assets of savers and investors kept in from of bank deposit either as

short-term demand deposit or in the form of certificates of deposit. So banks were the

main source of credit for both businesses and consumers. However, banking industry

gradually has lost its market share in both deposit gathering and lending since financial

deregulation occurred in many parts of the world. This trend encourages money markets

expansion significantly because of disintermediation process of banking industry;

frequently result to money outflow from the banking industry to money markets. The

Bank for International Settlements calculated that the total worth of money-market

instruments in rotation worldwide was 8.2 trillion US dollars at December 2004,

compared with 4 trillion US dollars at the end of 1995.29

Although, there is no standardized definition of the money markets but the word

is broadly employed as the complex of arrangements by which lenders and borrower are

brought together to buying and selling of debt instruments with the maturity of

maximum one year.30

The general purpose of participants of money market instruments are that

issuers are usually concerned with cash management or with financing their portfolios

28 Choudhry Moorad, The Money Markets Handbook: A Practitioner’s Guide (Singapore: John Wiley & Sons (Asia) Pte. Ltd., 2005) p.13. 29Marc Levinson, N. 26, p.37. 30 G. Walter Woodworth, The Money Market and Monetary Management (London: Harper & Row Ltd., 1965) p.3.

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of financial assets, while investors try to extending credit without taking any ownership

in the borrowing entity or management control.

2.6.1. Investing in Money Markets

Typically investors in money market do not purchase individual securities directly

but purchase money-market instruments through funds. Money–market funds are a

comparatively new innovation. The funds play an important role in expansion of money

markets since the funds are able to perform the role of intermediation at much lower

cost than banks. The movement of short-term capital from banks into investment funds

is most advanced in the United States because she began deregulating her financial

sector earlier. Investors in US money-market funds were 1.8 trillion US dollars in assets

in 2005. 31

2.6.2. Financial Instruments in Money Market

There are various types of instruments traded in money-market. The well-known

instruments include following:

Commercial paper (CP): It is a short-term funding instrument issued by a private

or a government corporation. Maturity of the instrument is less than 250 days generally

90 days. CP is an unsecured promissory note that first developed in the United States in

the late 19th century as early as 1922 and it became popular in the 1980s. Its merit is

that it allowed sound credit corporation to meet their short-term financing needs at

lower rates than directly lend from bank. 32

31 Marc Levinson, N. 26, pp.39-40. 32 Choudhry Moorad, N. 28, p.36.

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Bankers’ acceptances: It is also known as bills of exchange, bank bills, trade bills

or commercial bills. Bankers’ acceptances are the most traded securities in the money-

market. A banker’ acceptance is a promissory note issued by borrower and accepted by

bank to guarantee the return of debt. The banker’s acceptances are negotiable

instrument which can be sold in the secondary market. Usually, bank issue and resells

the note in the money markets at a discount. An investor who buys the note can collect

the loan on due date.33

Treasury bills: Treasury bills are also known as T-bills. These are securities with

short-term maturity of less than one year and issued by national governments. Treasury

bills are issued at a discount to par value, have no coupon rate, and mature at par value.

The bills account for a larger share of money-market trading. The U.S. Treasury is

considered as the largest single borrower in the world.34

Certificates of Deposit: Certificates of deposit or CDs are receipts from banks for

deposits that have been placed with them. They are receipt issued by bank when

soliciting wholesale deposits. CDs are often used by corporations, government, and

money-market funds to invest cash for brief periods of time. The merit of CDs are that it

facilitates lenders to get money back earlier whenever they need because the certificate

can be sold quite easily in money markets. The USA and EU are a very strong CDs

markets.35

33 Nico Swart, Personal Financial Management (South Africa: Juta and Company Limited, 2004) pp.149-150. 34 Esme Faerber, All about investing: the easy way to get started (New York: McGraw-Hill Professional, 2006) pp.124-125. 35 Stephen Valdez, N. 1, p.124.

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Repurchase Agreements (Repos): Repo is an agreement between a borrower and

a lender to sell and repurchase identical security on a particular date at a specified price.

It is one of the largest segments of the money-markets worldwide. Repos have a vital

role in money markets because they provide and maintain highly liquid for the markets.

Repos maturity can be very short as overnight or as long as six months but usually less

than 14 days.36

2.7. Bond markets

Bond markets are financial markets where buying and selling of bonds takes

place. Bond Markets facilitates fund raising by bringing together the investors and the

issuers of bonds those who want to invest and who require capital for their business

expansion. Trading in the Bond Markets is operated through electronic trading networks

and the Stock Exchanges.

The markets are classified into two sub-markets. One is primary market and

another is Secondary Market. In Primary Markets, the newly issue of govt. bonds and

corporate bonds are issued and traded between issuer and investor for the first time.37

Secondary Markets, where the outstanding bonds are traded between investors. This

market has significant role and serves several needs of issuers and investors. The market

provides the issuers with general information about market value of their outstanding

bond. It encourage investors to buy bond from issuer due to it offers them opportunity

to manage their liquidity position. It also reduces the costs of trading.38

36 Choudhry Moorad, N.28, p.103-104. 37 Frank J. Fabozzi, Steven V. Mann,ed, The Handbook of Fixed Income Securities (New York: McGraw-Hill Professional, 2005) p.31. 38 Ibid, p.39-40.

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Bond markets have their origin from the middle ages. The governments of them

several European city states issued bond to financing their warfare.39 As a result of the

rise in oil price in 1970s, size of global financial markets were significantly enlarges.

Subsequently, the bond market had increased in size more than fifteen times since the

1970s at the end of 1998, as large capital inflows to developed country banks from the

oil-producing countries took place. It made the bond market in US as the largest bond

market in the world.40

Today, bonds are the most widely used of all financial instruments. The total

magnitude of the bond market worldwide at the end of 2004 was 50 trillion US dollars

with 37 trillion US dollars traded on domestic markets and 13 trillion US dollars traded

outside the issuer’s country.41

2.7.1. Feature of Bond

Basically, Bonds are a form of debt which permit to pay interest on loan,

however, they are unlike bank loans because they can be traded in secondary market.

The basic features of bonds are maturity, coupon rate, provisions and options, and

currency denomination.

Maturity of bond is number of years over which the issuer has promised to meet

the obligation. It refers to the date that debt will end. Commonly, bonds with maturity

from 1 to 5 years are considered as short-term bonds, 5 to 12 years are intermediate-

term bonds, and above 12 years are long- term bonds. The term of maturity of a bond is

39 Ranalb C. Michie, No. 27, pp.17-18. 40Moorad Choudhry, The Bond and Money Markets: Strategy, Trading, Analysis (New Delhi: Butterworth-Heinemann, 2001) p.8-9. 41 Marc Levinson, N. 26, p.58.

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important by many reasons. It indicates the period of interest payment before the

principal will be paid. The yield on a bond depends on it. Degree of price volatility of a

bond is dependent on its maturity; the longer maturity is associated with greater price

volatility resulting from a change in interest rates.42 Par value is the amount that the

issuer agrees to redeem at maturity date. Par value also referred as the face value,

maturity value, or redemption value.43

Currency denomination is other feature of bond. The payments to bondholder

can be any currency. For example, a bond issued in the United States usually makes

coupon payments and principal redemption in U.S. dollar. However, it can make

payment in some other specified currency. Bond payments in U.S. dollar are called a

dollar- denominated issue and non-dollar-denominated issue if it is paid in other

currencies. Issue that makes coupon payment in one currency and makes principle

redemption in other currency is called dual- currency issue.44

Coupon rate is the rate of interest that the issuer agrees to pay each year,

normally annual payment but UK, US and Japan practice two semi-annual installments.

The coupon rate of a bond also reflects its price in market sensitively.45

Sometime a bond is featured by provision or options that the bond give to its

issuer or holder. Though such call and refunding provision which issuer gains the right to

buy the bond back or retire the bond before maturity date. Sometime the provisions

give to bond issuer in from of pattern for paying off bonds. It can be in one lump sum 42 Frank J. Fabozzi, N.24, pp. 208-209. 43 Frank J. Fabozzi, The Handbook of Fixed Income Securities (New York: McGraw-Hill Professional, 2000) pp.5-6. 44 Frank J. Fabozzi, N.24, pp. 213. 45 Moorad Choudhry, An Introduction to Bond Markets (England: John Wiley & Sons Ltd, 2006) p.5.

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payment after maturity date which is called a bullet maturity or have a schedule of

partial principal payment which is called amortizing securities. In some case bond is

characterized by option to take some action against the opposite party. Put option46 and

convert option47 are the most common type of option.48

2.7.2. Type of bonds

There are different ways to classify the bonds: such as the way they pay their

interest, the type of issuer, the currency they would be paying, protective features and

their legal status. Some of the significant types of bonds are discussed below:

Government and corporate bonds:

Government bonds are bonds that are issued by the government of any country.

The bonds issuer can be central government, local government, or government

corporate body. When a bond is issued by central government it is referred as sovereign

bonds. If it issued by local government or government corporate body it is called semi-

sovereign or municipal bond.49 Government bonds are considered as the backbone of

fixed-income securities, because they play as benchmark of the market.50A corporate

bond is a bond issued by a private company. Most corporate bonds are considered

riskier than those of governments, so they usually offer a higher yield.51

46 Putoption is the option granted to the bondholder that he can sellback the bond to its issuer at specified price on specified date. 47 Convert option is the right granted to bondholder that he can exchange the bond for a specified number of shares of common stock of issuer. 48 Frank J. Fabozzi, Fixed Income Analysis (New Jersey: John Wiley & Sons Inc., 2007) pp.8-15. 49 Marc Levinson, N. 26, pp.60-61. 50 World Bank, International Monetary Fund, Developing Government Bond Markets: A Handbook (USA: World Bank Publications, 2001) pp.3-4. 51 Nigel Gibson, Essential Finance (London: Profile Books Ltd, 2003) p.88.

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Callable bonds and Putable bonds:

Callable bonds are bonds that the bond issuer reserves a right to buy the bonds

back at particular date on a specified price. In contrary, putable bonds are bonds that

give the right to investor to sell the bond to the issuer at par on specified dates.52

Eurobonds:

Eurobonds are bonds issued in a currency that is not native to the country where

it is issued. Such as bonds issued in US dollar in London or Japanese yen bonds issued in

New York are categorised as Eurobonds.53 Eurobond has been referred to as

international bond because it can be issued across national boundaries and can be in any

currency.54

Zero-coupon bonds:

Zero coupon bonds are bonds that do not pay interest during the life of the

bonds. Investors buy zero coupon bonds at a deep discount from their face value, which

is the amount a bond will be worth at the time of maturity. Purchasers get their profit

from the difference between the market price and the bond’s face value at maturity

date.55

Convertible bonds:

Convertible bonds are the bonds that can be converted into a predetermined

amount of the issuer's equity at certain times during their life. According to conversion

feature, the bond allows the bondholder to convert the bond into a specified number of 52 Peter Howells and Keith Bain, Financial Markets and Institutions (England: Pearson Education Limited, 2007) p. 153. 53 Moorad Choudhry, N.45, pp.152-153.

54 Moorad Choudhry, No.40,p.10. 55Nigel Gibson, N. 51, p.314.

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shares of the issuing company at a set price on maturity or at specified times during the

bond’s life.

Convertible bonds often issued by issuers who find difficulty to offer

conventional paper. The feature of conversion of bond is designed to make the bond

more attractive to investors, as they have a chance to gain more from a rise in the

issuing company’s share price. As the bonds gain more attraction, this allows issuer to

raise a higher amount at one issue, compared with other type of bond. 56

2.8. Equity markets

Equity or share or stock is an instrument that indicates an ownership position in

a corporation, and represents a claim on its proportional share in the corporation's

assets and profits. Stockholders usually receive dividends as a portion of the company’s

profit, when the company earns profit. Stockholders also make a profit on stock by

buying it at lower price and selling it at a higher price. Ownership in the company is

determined by the number of shares a person owns divided by the total number of

shares outstanding. This instrument is an important tool for issuer companies to rise

their fund or manage their financial risk. However, the instrument can be used only by a

certain type of company called a corporation; other types of companies such as limited

company cannot issue stock. Stocks are traded in stock exchanges. These market places

are organized and supervised; trades are made based on an approved set of rules and

regulations. The markets are considered as secondary market where stocks are

consequently traded after first publicly offered (initial public offering or IPO). Stock

exchange transactions are involved by dealers (principals) and brokers (agency); dealers

buy and sell from their own portfolios, or inventories of securities. While, brokers 56 Moorad Choudhry, N. 45, p. 158-159.

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perform trades on behalf of clients and receive commissions and fees for their

services.57

The idea of share ownership on business enterprise can be located back to the

medieval age. In the Renaissance period, the idea was widespread as groups of traders

joined to finance trading expeditions and early bankers took part ownership of

businesses to ensure repayment of loans.58 The early joint-stock companies were

emerged as a way to merchant enterprise seeking capital to fund maritime trade, to

spend risk for far distant sea trade, but extremely profitable. Thus, most early stock

exchanges developed at trade port area where as brokers gathered to trade shares and

the investor could see what stocks are represented. The establishment of the Russia

Company in 1553, the first English joint stock company, was a good example. This

company was formed to fund exploration of Northwest passage to Asia via the Arctic

Ocean. Its offering to sale stock was much like an Initial Public Offering (IPO) in present

day. By late 17th century share trading stared widespread. During the 18th century,

stocks were generally used to created companies for constructing infrastructure needs

of industrial civilization as Canals, ironworks, port. England was considered the leader in

such stock companies. 59

After 1990s, the markets experience a great expansion in stocks trade value

around the world. This situation was a result of reduction of government intervention.

Furthermore, development in communications and computing technology made

57 Robert A. Schwartz and Reto Francioni, Equity Markets in Action: The Fundamentals of Liquidity, Market Structure & Trading (New Jersey: John Wiley & Sons, Inc.,2004) p.1. 58 Marc Levinson, N. 26 p.129. 59 Syed B. Hussain, ed, Encyclopedia of Capitalism: v. 3 (New York: Facts On File, Inc., 2004) pp.800-801.

44

electronic trading network available at low cost60, the wake of the privatization

programs, and emerging new markets around the world especially in former communist

states. In Eastern Europe stock exchanges emerged in Budapest in 1990, Warsaw in 1991

and Prague in 1992. A stock exchange was established in Botswana in 1994. In the

Middle East, stock exchanges gradually emerged in many part of the region such as

Palestine in 1997 and Saudi Arabia in 2001 whilst two appeared in Dubai in 2005. From,

1990 onwards organized markets for corporate stocks spread to almost every country in

the world irrespective of their size, level of economic development, or political regime.61

By 2005 the capitalization of the world’s stock markets had exceeded 36 trillion US

dollars.62

2.8.1. Equity instruments

Ordinarily, the classes of shares or stocks can be divided into two categories,

common and preferred stock. Although, both represent part of ownership of designated

enterprises but they differ in some respects. Common stock is basic type of share in a

company, called ordinary share in the UK. It is security representing equity ownership

with voting right in a corporate company. The common stock holder has the right to

vote, according to proportion or number of stock, to elect members of the company’s

board of directors as well as on major decisions. In the event of liquidation, common

stockholders have rights to a company's assets only after bondholders, other debt

holders, and preferred stockholders have been satisfied. The market value of common

stock tends to fluctuate more than preferred stock.

60 Ranald C. Michie, N.27, p. 297. 61 Ibid, pp. 313-134. 62 Marc Levinson, N. 26, p.129.

45

Preferred stock is other type of equity that is used by cooperated enterprise. It

also represents portion of ownership as common stock do. However, preferred

stockholders do not have the voting right. So, they cannot participate in election for

company’s member of the board of directors or in other major decision of the company.

However, preferred stockholders are given prior right over common stockholders in the

matter of dividends and in claim upon remaining assets, if corporation closes down its

operation. Dividends of preferred stock is prior as it stated in advance and do not tend

to fluctuate as much as common stock dividends. Sometime dividends of preferred

stocks are “cumulative” meaning that if dividends of preferred stocks are not declared

or paid the non-declared or non-paid dividends are considered to be “owed”. As long as

the preferred dividends are owed, no common stock dividend are declared or paid.63

2.9. Derivatives Markets

The financial derivatives refer to financial instruments whose values are based on

or derived from other, which are named as underlining. Their financial contracts are

designed to create market price exposure to changes in an underlining. The underlining

could be common stocks, bonds, currencies, interest rates, exchange rates, and market

indices. Moreover, derivatives value can be based on more than one underlining, for

example it could be based on the difference between a domestic interest rate and a

foreign interest rate.64

Today the size of derivatives markets is enormous. Some measures indicate that

derivatives size exceeds bank lending, securities and insurance. Data by the Bank of

63 Burton S. Kaliski, ed, Encyclopedia of Business and Finance, v.1 (New York: Macmillan Reference USA, 2001) pp.197-198. 64 Robert W. Kolb and James A. Overdahl, Financial Derivatives (New Jersey: John Wiley & Sons, Inc., 2003,) pp.1-2

46

International Settlements (BIS) indicates that the OTC derivatives market of all

categories of OTC contracts rose to 592 trillion US dollars at the end of December

2008.65While derivative instruments traded at derivatives exchanges exceeded 59.7

trillion US dollars of which 20.1 trillion US dollars came from future contacts and other

39.6 trillion US dollars came from option contacts during the same period.66

The financial market for derivatives is known as the derivative market. The

market can be divided into, exchange traded option and over-the-counter derivatives.

2.9.1. Type of derivatives markets

Exchange-Traded Derivatives: These markets are considered as an organized

market. These are the derivatives products that are traded via specialized derivative

exchanges. A derivative exchange acts as an intermediary to all related transactions. The

exchange-traded financial derivative came to age in 1975 in US when the Chicago Board

of Trade (CBOT) was developed. This was followed by establishment of London

International Financial Futures and Options Exchange (LIFFE), the first exchange-traded

derivative of Europe in 198267

The Over- the- Counter derivatives (OTC): The derivatives traded over the

counter are known as the over the counter derivative market. It is the fastest- growing

part of derivatives markets. About 84% of derivatives contract were arranged in this

65 Bank for International Settlements, OTC derivatives market activity in the second half of 2008 (Switzerland: Bank for International Settlements, Monetary and Economic Department, May 2009)p.1 66 Bank for International Settlements, BIS Quarterly Review: International banking and financial market developments (Switzerland: Bank for International Settlements Press & Communications, March 2009 )p. A.108 67 Mike Buckle, John L. Thompson, The UK Financial System: Theory and Practice (UK: Manchester University Press, 1998)pp.261-262.

47

market at the end of 2003.68The Over the counter derivative markets are transactions

agreement between two parties without the exchange intermediation. Generally, the

two parties or counterparties consist of dealer as a bank or investment bank, clients like

hedge funds, commercial banks, non-financial, and corporation government sponsored

enterprises69

2.9.2. Financial derivative instruments

Derivatives can be broadly categorized as either standardized or customized.

Standardized derivatives are those derivatives traded on the organized exchanges where

simplicity is critical. Derivatives are designed to be standardized when the objective are

designed to acquire the widest potential participants by keeping the specifications as

simple as possible. In contrary, derivatives can be customized in response to very

specific needs of an end user. They can be designed with great flexibility with unusual

durations, quantities, price leverage, etc. Because of they lack of standard and critical

handling. Most of customized derivatives are traded in the Over- the-

Counter.70Although, there are a numbers of types of derivatives available in the market,

they can be grouped into four basic type of contract as option, future, forward, and

swap contract71An options is a contract between a buyer and a seller that buyer get the

right, but not the obligation, to require the option writer to perform a specified action

within specified period. For example an option on equity gives the buyer the option, not

68 Robert E. Whaley, Derivatives: Markets, Valuation, and Risk Management (New Jersey: John Wiley and Sons, Inc., 2006) p.3. 69Marc Levinson, N. 26, p.217. 70Philip Mcbride Johnson, Derivatives: A Manager's Guide to The World's Most Powerful Financial Instruments (New York: The McGraw-Hill, 1999) pp.1-2. 71 Brian A. Eales and Moorad Choudhry, N. 15, p.1.

48

the obligation, to purchase that equity from the writer within a specified time period

and agreed price or leave the option. The price that buyer pays to buy an option is called

premium. The last date of specified time period is called offset or expiration date. The

agreed price is called strike price.72

A forward is an over-the counter instrument. It is basically bilateral agreements

with often customized character and has no active market. It is agreement between two

parties to buy or sell an asset at a pre-arranged quantity, future time and price.73 A

futures contract is basically a forward contract. However, it is considered more standard

and less risky than forward contract because it is traded on an organized financial

exchange such as the Chicago Mercantile Exchange.74

A swap is an agreement which two parties, called counterparties, agree to

exchange payments at designated period of time. A party and B party agrees to

exchange fixed interest payment with floating interest payments, for example.75 Since

swaps were first introduced, Swaps have become important component of the Over-

the- Counter derivatives market. Because it can be used to reduce finance costs, hedge

price risks, reduce taxes, reduce transaction costs, and much more.76 Basic types of

72 Dimitris N. Chorafas, Introduction to Derivative Financial Instruments: Options, Futures, Forwards, Swaps, and Hedging ( New York: MeGraw-Hill, 2008) pp.39-40. 73 Ibid, p. 40-41. 74 Robert W. Kolb and James A. Overdahl, N. Financial Derivatives (New Jersey: John Wiley & Sons, Inc., 2003,) p.4. 75 Robert W. Kolb and James A. Overdahl, Futures, Options, and Swaps (England: Wiley-Blackwell, 2007) pp.5-6. 76 John F. Marshall, Dictionary of Financial Engineering (New York: John Wiley & Sons, 2000) p.2000.

49

swaps are interest rate swaps, currency swaps, equity swaps, commodity swaps and

credit swaps.77

2.10. Economic thought of Islamic

As a complete way of life, Islam has provided guidelines and rules to its

adherents for every sphere of life and society material as well as spiritual. Economic

matter is also not excluded in this divine guideline. Although, the fundamental subject of

all economic thought is share a common idea and strategy to satisfy the human wants

and maintain social well being. But different worldviews of different thoughts lead to

different approaches that they use to achieve their goal. For example, one and most

fundamental difference that separates Islamic economic thought from others is idea of

scarcity of resources. According to Quran, God has created sufficient resources for His

creatures. Thus, any scarcity occurs either due to improper utilization of natural

endowments or an imbalanced distribution. So Scarcity of resources is man- made

situation.78This is the Islamic worldview towards economic matter which is in sharp

contrast with that of western mainstream economics. Therefore, to make understand

the concept idea of Islamic economic and financial thought one should first try to

understand Islam which is its origin.

77 Robert W. Kolb and James A. Overdahl, N. Financial Derivatives (New Jersey: John Wiley & Sons, Inc., 2003,) p.166. 78 M. Akram Khan, Islamic Economic: Nature and Need, Journal of Research in Islamic Economics, vol.1 No.2 p.51, 1984.

50

2.11. General knowledge about Islam

2.11.1. Islam

The word Islam is an infinitive of the fourth form of the Arabic triliteral root s-l-m

meaning “to submit,” “to surrender”. Meaning of the word Islam is “submission” or

“surrender” which refers to submission to the will of God which is considered the

greatest accomplishment for humanity in the personal as well as societal realm. Muslims

believe that ultimate peace can be achieved by submitting the will of God and putting

oneself in God’s hands. The word submission or surrender in this sense does not bear

any sense of negative connotations as it often does in popular contexts. Because the

actions will be done by believers with their conscious for all the benevolence that God

has bestowed upon humanity. 79

The word “Islam” is used to identify the faith tradition as well as community of

those who believe in one God, called “ALLAH” in Arabic. The Islamic adherents is called

“Muslims” and regard the Prophet Muhammad (PBUH) as the last and most perfect of

God’s messengers. The holy QURAN is the sacred scripture of Islam, which contains

God’s revelations.80

Islam is one of the major religions of the world. It is followed by around one-fifth

of world’s population. It is the major religion in countries throughout the Arab world,

Asia, and most of African countries. It is minor religion in America and Europe, and the

rest of the world. Islam is also one of the major “monotheistic” religions, in which

79 Masoud Kheirabadi, Religious of The World: Islam (USA: Chelsea House Publishers, 2004) p.3. 80 Richard C. Martin, “Encyclopedia of Islam and the Muslim World” (New York: Macmillan Reference USA, 2004) pp.359-360.

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believers belief in the existence of one god, the other two being Judaism and

Christianity81

Islam is both a religion and a civilization that spans over fourteen centuries of

history and a geographical presence in vast areas over the Asian and African continents

and even parts of Europe. It is also a spiritual force that has transformed the inner and

outer life of human being in very different temporal and spatial circumstances. At the

present time more than1.2 billion people from different ethnological and cultural

backgrounds are Muslim. Historically Islam has played an important role in the

development of certain aspects of other civilizations, especially Western civilization. As

evidence shows, its influence is also present in the history of the Christian West, India

and other regions of Asia and Africa.82

2.11.2. Who is a Muslim?

Muslim means “a person who submits.” in Arabic. It alludes to a person who

follows Islam and obeys to the God’s will. In principle, Muslim is a person who rejects

the worship of everyone except God. However, some formal procedure has to be made

for becoming a Muslim. To join Islam a person has to make the formal declaration of

faith, “There is no god except God and Muhammad is the messenger of God”. The

declaration implies that the declarer belief in God and obey all His attributes, His

messengers, and the entire messages that they brought. When one made declaration of

81 Mark J. Sedgwick, Islam & Muslims: A Guide to Diverse Experience in A Modern World (USA: Intercultural Press, a Nicholas Brealey Publishing Company, 2006) p.2. 82 Dr Seyyed Hossein Nasr, ISLAM: Religion, History, and Civilization (Australia: HarperCollins Publishers (Australia) Pty. Ltd., HarperCollins e-books, 2007) p. vii.

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faith, the recitation leads one an obligation to accept the six beliefs and perform the five

pillars as fundamental obligations of Muslim.83

2.11.3. Allah (SWT)

“Allah” is the Arabic term equivalent of the word “God” in English. The name

Allah is the standard Arabic word for “God” which it is probably a contraction of the

Arabic al-llah, meaning “the god”. This term is used not only Arabic-speaking Muslims

but also Jews and Christians as well. Allah (SWT) is described as the One, forever, neither

born nor bearing, not having an equal. He is the creator of the universe and its judge,

the lord of the world, the most high, merciful, most compassionate, all-knowing, all-

seeing, rewarder of good and punisher of evil. In addition, Muslims characterize him by

the ninety-nine name which is known as “most beautiful name” which serves to identify

his attributes.84

Allah places at the pivot of Muslim faith, the one and only God in Islam. As one

see the name of Allah (SWT) occurs in the “Shahada”, profession of faith, the earliest

and most important Islamic creeds which in its the first part the believer declares that

there is no god but God (Allah). According to Encyclopedia of Islam and the Muslim

world (2004), a fine summary of basic Islamic teaching regarding to God can be seen in

the famous “Throne Verse” (2:255) “Allah! There is no god but He, the living, the

Everlasting. Neither slumber nor sleep seizes him. His are all things in the heavens and

the earth. Who is there who can intercede with Him, except by His leave? He knows

what is before them and what is behind them, while they comprehend nothing of His

83 Arshad Khan, Islam, Muslims, and America : Understanding The Basis of Their Conflict (New York: Algora Publishing, 2003) p.135. 84 Jacob E. Safra, ed, Britannica Encyclopedia of World Religious(Chicago: Encyclopedia Britannica, Inc. 2006) p.34.

53

knowledge except as His wills. His throne extends over the heavens and the earth.

Sustaining them does not burden Him, for he is the Most High, the Supreme”85

2.11.4. The Prophet Muhammad (PBUH)

Prophet Muhammad (PBUH) was born in Mecca in 570 C.E. into the Hashimite

clan of the tribe of Quraysh. At the age of forty, he received his first revelation of the

Quran, during the Ramadan month. Beginning with the first five verses of the ninety-

sixth Surah of the Quran, he received revelations from God through the archangel Jibril

for the rest of his life. He and his followers were forced to migrate from Mecca to

Medina in the year 622 C.E., this event are known as Hijra and was the starting point of

Muslim date events A.H.. He died in 632 C.E/10A.H. at the age of 62.86

For Muslims, Muhammad (PBUH) was the last of a long line of prophets to whom

God has revealed his truth, the line begins with Adam and many figures familiar to Jews

and Christians such as Noah, David, Solomon, and Jesus. Muhammad (PBUH) represents

more than the vehicle for God’s revelation, He also exemplifies the ideal way of

responding to it. His life was regarded as ideal act of Muslims. Therefore, Hadith, the

collecting accounts of his sayings and deeds, is very essential guidance on religious

matters which one should concern about many daily activities.87

2.11.5. The Holy Quran

The Holy Quran is the final divine revelation of Allah (SWT). It contains Allah

(SWT) divine message to humanity as revealed to His prophet Muhammad (PBUH). The

85 Richard C. Martin, N.80 p.41. 86 Gordon D. Newby, A Concise Encyclopedia of Islam (Oxford: Oneworld Publications, 2004) pp.154-155. 87 Robert S. Ellwood, ed, The Encyclopedia of World Religious: Revised Edition (New York: Facts On File, Inc., 2007) pp.304-305.

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divine message contains in the holy Quran is considered as the last and complete stage

in a long series of divine messages conducted through messengers or prophets chosen

by God starting with Adam, The first man of earth, and ending with prophet Muhammad

(PBUH)88. Furthermore the holy Quran is also regarded as the infallible message of

God.89

As supreme authority, the holy Quran is fundamental and paramount source of

the creed, rituals, ethics, and laws in Islamic religion. The supreme status of it came from

the belief that the holy Quran is the word of God, revealed to the Prophet Muhammad

(PBUH) via the archangel Gabriel, and intended for all times and all places. It was the

starting point of all the Islamic sciences. As the celebrated fifteenth-century scholar and

author Suyuti90 said, “Everything is based on the Quran” as the whole religious life of the

Muslim world is building around the text of the holy Quran. 91

88 Besides The Holy Quran, Muslims believe that four other books also originated from God and are to be regarded as Holy Scripture. these four Holy Books are: • The Scrolls (Suhuf ) Ten scriptures (now lost or untraceable) revealed to the Prophet Abraham (Quran 2:129; 53:39). • The Torah (Taurat) The Holy Book revealed to the prophet Moses (Quran 2:50;3:2; 5:72). • The Psalms (Zabur) The Holy Book revealed to the prophet David (Quran 4:163). • The Gospels (Injil ) The Holy Book revealed to the prophet Jesus (Quran 3:2;5:72; 57:26). 89 S. A. Nigosian, Islam : Its History, Teaching, and Practices (Indiana: Indiana University Press, 2004) p.65. 90 al-Suyuti (1445-1505 A.D.):Egyptian writer and teacher whose works deal with a wide variety of subjects, the Islamic religious sciences predominating. His full name was Abu'l Fadl Abd al-Rahman ibn Kamal al-Din Abi Bakr ibn Muhammad ibn Sabiq al-Din, Jalal al-Din al-Misri al-Suyuti al-Shafi'. He was the one of the greatest scholars and thinkers of the fifteen century. He was a great genius and a great scholar. He continued throughout his life to write extensively on the Qur'an, hadith, Shari'ah, History, philosophy, rhetoric, etc, and contributed a great deal to the world of knowledge. He authored works in virtually every Islamic science. It is said that his books number nearly six hundred. 91 M.A.S. Abdel Haleem, The Quran: A New Translation by M.A.S. Abdel Haleem (New York: Oxford University Press, 2004) p.ix.

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2.12. Sources of the Islamic economic thought

Fundamentally, Islamic economic thought is a subset of Islamic law. The law is

that incorporates the rules of Muslims life for all kind of aspects economically, socially,

and religiously. The law is known as Shariah law which is a code for life. The Shariah law

has been developed on the basis of two main sources. The priority and supreme sources

that were established the during the prophet lifetime which are known as the holy

Quran and the Sunnah. These two very basic sources of Islam contained a number of

economic principles and many detailed economic teachings. In addition, two other

sources were derived from the primary sources which are known as Ijma and Qiyas.92

2.12.1. The Holy Quran

The holy Quran contains the scriptures of Islam. Muslims believe it be the word

of God as revealed to the Prophet Muhammad (PBUH). The holy Quran compose of 144

chapters, Suras in Arabic, were delivered in a period of twenty – three years of

Muhammad’s (PBUH) Prophethood. Certainty, status of the holy Quran in Islamic law is

absolutely supreme. However, the main part of the holy Quran is not dealing with the

provision of law but with beliefs and moral conduct. Only about 500 verses out of 6342

verses deal with the provision of law. Basically, verses in the holy Quran can be divided

into two group, Mecca and Medina verses. The Mecca verses were short and brief, they

were concerned with faith, and moral education. The Medina verses, long and detailed,

concerned with legislation.93

The holy Quran texts were written during the revelation by a team commissioned

by the Prophet (PBUH). The correct of texts order, verses and chapter, was approved by

92 Ahmed A.f. El-Ashker and Rodney Wilson, Islamic Economics: A Short History (Boston: Brill, 2006) p.32. 93 Jamal J. Nasir, The Islamic Law of Personal Status (London: Graham & Trotman Ltd., 1990) pp.19-20.

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the Prophet (PBUH). However, compilation of the Quran as one book was made in the

caliph Abu-Bakr period, two year after the Prophet’s death. The copy was made to be

the master copy in the caliph Uthman regime. This master copy has been used by

Muslims since then.94

2.12.2. The Sunnah and Hadith

The Sunnah of the Prophet (PBUH) is one of the most important sources of

Islamic law. The status of Sunnah as sacred guidance was approved many time in the

Quran such as “whatsoever he forbids you, abstain from it” (59:7) and “whoso obeys the

Messenger indeed obeys Allah” (4:80).95

The Hadith is another word that is used almost synonymous with Sunnah. Both

words convey the same meaning. Both words refer to normative model behaviour of the

Prophet (PBUH) which consists of the Prophet’s sayings, his deeds, and his silent

approval. The Sunnah and Hadith play an important role in Islamic law as they provide

details and clarity of example that has been generalized in the holy Quran verses.96

Although the process of preserving Hadith in text form started during the period

of the Prophet, in addition to the verbal transmission of Hadith, but attempt to collect

the Hadith did not come until mid eighth century. The first attempt to collect the Hadith

in from of text book took place in the reign of Caliph Umar ibn Abel-Aziz of Umayyad

dynasty. There were three main reasons behind the collection. The death of many

Hadith memorisers. The dispersion of Hadith memorisers made it difficult to trace them

94 Ahmed A.f. El-Ashker and Rodney Wilson, N. 92 p.33. 95 Mohamed Taher, ed, Encyclopaedic Survey of Islamic Culture (New Delhi: Anmol Publications Pvt. Ltd., 1998) p.21. 96 Muhammad Hamidullah, The Emergence of Islam (New Delhi: Adam Publishers and Distributors, 2007) pp.43-44.

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for consultation on Hadith verification. And to protect Muslims from misinterpreted

Hadith.

Furthermore, a unique method called “Isnad” was adopted to ensure the

accuracy of the hadith. The method is that every hadith is supported by a chain of

informants, referred by name, starting from the last one who report the Hadith to the

first one who himself reported to hearing or seeing the Prophet saying, doing or

approving.

Since then there are many Hadith books available. However, Sahih Al-Bukhari

and Sahih Muslim are widely mentioned,.97

2.12.3. Ijma

Ijma are regarded as the third sources of Islamic law. Technically, the term “Ijma”

is that consensus of the Muslim scholars of given generations to formulate independent

judgment in a legal question based on the holy Quran and Hadith. When the Muslim

community faces a problem that its explicit result cannot be found in the holy Quran and

the Hadith. The Muslim scholars come together and decide on the issue in the light of

the holy Quran and the Hadith. Such unanimous decision become source of law.98

However, Ijma is applied only to secular matters. It is not applied to Ritual issues. Since,

rule of worship in the Quran and the Hadith are always explicit.99

97 Ahmed A.f. El-Ashker and Rodney Wilson, N. 92, p.35. 98 Saadudin A. Alauya, Fundamentals of Islamic Jurisprudence: With Appendix, Islamic Penal Law (Philippines: Rex Bookstore, Inc, 1999) pp.64-65. 99 Ahmed A.f. El-Ashker and Rodney Wilson, N.92, p.36.

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2.12.4. Qiyas

Qiyas is the fourth source of Islamic law. Generally, Qiyas means ‘judging or

comparing something with some other thing.100 In Islamic law, this term means to use

human reasoning to apply an existing legislation (in the holy Quran, the Hadith, and

Ijma) with new circumstance. When the rationale of legislation is known, other similar

cases can be judged according to the same rationale. Such as, the holy Quran prohibits

alcohol in chapter 5 verse 90. By analogy this prohibition is extended to anything that

cause intoxication whether it is liquid or powder or another form since the effective

cause is intoxication.101

Ijma and Qiyas are considered as secondary source of Islamic law after the Quran

and the Hadith. After death of the Prophet, two principles were developed as secondary

source of Islamic law, to meet any new issue that did not exist during the Prophet’s

lifetime. These two principles allow Muslim scholars to use their logic and analogy to

find out solution of new issue within the light of the Quran and the Hadith.

The permission of use of Ijma and Qiyas as source of Islamic law can be seen in

the Hadith that the Prophet (PBUH) was reported to have told Abu Musa Ashari:

“Judge upon the Book of Allah. If you do not find in it what you need, upon the Sunnah of the Prophet (PBUH) and if you do not find in that also, then use your personal opinion”102

As pyramid shape, the holy Quran stands at the top of the pyramid as it is God’s

revelation to the Prophet (PBUH). Below it are the Sunnah and the hadith of the Prophet

100 Mufti M. Mukarram Ahmed, Encyclopaedia of Islam (New Delhi: Anmol Publications Pvt. Ltd., 2005) p.123. 101 Daniel W. Brown, A New Introduction to Islam (UK: Wiley-Blackwell, 2009) p.158. 102 Mufti M. Mukarram Ahmed, N. 100 , p.123.

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(PBUH) which are considered as explanation and sample of the holy Quran for Muslim.

Finally Ijma and Qiyas will be used when issues and questions not addressed by the

primary sources as assurance of freedom from error.

2.13. Prominent feature of Islamic economic

Unlike the mainstream economic systems which are based on the mundane

philosophy. The core of Islamic economics centers on the spiritual norms of Islam. Hence

Islamic economic system has been laid its entire feature on the base of norms which

were already provided in the holy Quran and the Sunnah. Whether it is production,

consumption, distribution or the financial system, they all have been provided.

According to Islam, Allah (SWT) owns all resources and man is only a trustee in

their use. Therefore, man is not completely free to utilize. But the use of those resources

are limited by Allah’s order, the truly owner of all thing. Thus Islamic economic limits

man’s freedom to use of the resources by taking Allah’s order into account. Allah’s

(SWT) order that man can earn his livelihood only through Halal mean103

Halal104 and Haram105 is one of the most distinctive features of the Islamic

economic vis-à-vis mainstream economic. This concept reigns supreme in the realm of

production as well as consumption. Fundamentally, all activities of Muslims are judged

on what is Halal and what is Haram. Except of whatever activities, profession, contracts

103 Muhammad Akram Khan, An Introduction to Islamic Economic (New Delhi: Kitab Bhavan, 1999) p.6. 104 Halal ( حالل) is an Arabic term designating any object or an action which is permissible to use or engage in, according to Islamic law. 105 Haram ( حرام‎) is an Arabic term meaning "forbidden". In Islam it is used to refer to anything that is prohibited by Allah.

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and transactions that have been explicitly prohibited by the Quran and the Sunnah of

the Prophet (PBUH) all other are considered Halal.106

Halal and Haram (lawful and unlawful) is an influential principle on Islamic

economics. It relate with three aspects of life, edible things, financial matters, and daily

business. For example, in consumption matter Islam encourages its believer to eat and

utilize everything, not ask their devotees to pass an ascetic life in this world and enjoy a

better life in the next world as some other religions. However, they are not allowed to

consume Haram item such as carnivorous animal, pork, intoxicate item. Allah orders the

Muslims to eat and to utilise the produce only in a Halal way. In financial matters all

types of usury and interest (Riba) were Haram and their dealings and practice were

declared a deadly sin. In the daily business, gambling, cheating, fraud, games of chance,

bribes, theft, dacoits, murders, monopoly and hoarding all are declared illegal and

unlawful. Thus, although an activity may be economically sound. But if the action is

regarded Haram, It is not allowed in the Islamic society.

Other prominent feature of Islamic economics is distribution of wealth. Even

though, justice wealth distribution is recognized in every economic system, but only

Islamic economic thought places this doctrine on the first consideration. The wealth

distribution has been highly emphasized in Islamic system. Islamic economic system

combats the accumulation of wealth and wealth concentration in the hand of a few. A

number of Islamic order directly concern with provision of social justice and wealth

distribution. Significant principles are Zakat inheritance law and interest prohibition.107

106 Muhammad Akram Khan, Islamic Economic and finance: A Glossary (London: Routledge. 2003) p.70. 107 Abdulkader Thomas, ed, Interest in Islamic Economic: Understand Riba (New York: Routledge, 2006) p.103.

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Zakat is an act of worship which is included in the five pillar of Islam. Zakat is a

compulsory payment imposed on the wealthy Muslims. Zakat is not charity which is

option or taxes which must be given to Islamic state and used in every purpose by state.

But it is a special religious obligation of the wealthy Muslims to distribute their money,

in exactly ratio, to such people that specify in Quran as the poor, the needy, to free

captive and debtors, for travelers in need, to new converts. Thus the wealth is shared

between the rich and the poor and needy.108

As far as distribution of wealth is concerned, inheritance law of Islam provides

other measure to obstruct wealth concentration whereby heritage is distributed among

various members of the family. According to Islamic inheritance law heritage must be

allocated among parents, partner, children, brothers, sisters and cousins of the dead in

proportion that is specified by Islamic law.109 Prohibition of Interest and usury provide a

protection for imbalance socioeconomic structure. Since interest prohibition intends to

prevent the accumulation of wealth in a few hands. The main purpose of interest

prohibition is to block the process that transfers wealth from the poor to the rich,

deteriorating the wealth distribution.110

So one can say that Islamic economic is a comprehensive system of ethics and

moral value with socio-economic and distributive justice.

108 Mufti M. Mukarram Ahmed, N. 100, pp.66-67. 109 Ahmed Abdel-Fattah El-Ashker, The Islamic Business Enterprise (New South Wales: Croom Helm Ltd, 1987) p.2. 110 Muhammad Ayub, Understanding Islamic Finance (England: John Wiley & Sons Ltd, 2007) pp.54-55.

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2.14. Islamic finance

The structure of Islamic finance is firmly rooted in Islamic economic thought

which is based on the holy Quran, the Sunnah of the Prophet (PBUH) and the

interpretations of those sources of revelation by Islamic jurisprudences.111 Therefore,

Islamic finance dose not simply mean interest free banking. But, it means indeed to

finance taking Islamic values into account on its objective and operation. So, Islamic

finance goes beyond just finance with interest free characteristic. In addition to

avoidance of interests, Islamic finance also avoids Gharar112 activities, focuses on Halal

activities, quest for justice and other religious goal.113

2.15. Main Principle of Islamic finance

Islam has limited the freedom to involve in business and financial transactions on

the basis of a number of prohibitions, ethics, and norms. Besides major prohibitions,

Islamic law has prescribed a number of other norms and boundaries in order to avoid

inequitable gains and injustice.

As a rule, Shariah has determined some elements which must be avoided in

commerce or business transactions. In this regard, the prohibition of Riba, Gharar and

gambling are the most strictly factors that defines invalid and voidable contracts.114

111 Frank E. Vogel and Samuel L. Hayes, Islamic Law and Finance: Religion, Risk and Return (Boston: Brill, 2006) pp.1-2. 112 Gharar is Arabic term describing risk, uncertainty, hazard and speculation.

113 Ibrahim Warde, Islamic Finance in the Global Economy (Edinburgh: Edinburgh University Press, 2000) p.5. 114 Muhammad Ayub, N.110, p.43.

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2.15.1. Prohibition of Riba

Prohibition of riba stands at the core of Islamic financial doctrine as it is deemed

to be the starting factor of all socioeconomic evil. In Holy Quran, the prohibition of riba

is revealed in four different contexts. First, describes that riba deprives wealth of God’s

blessings. Second, riba is condemned as wrongful allocation of property belonging to

others. Third, the revelations encourage Muslim to clear their own sake. Finally, the

revelation distinguish that riba is totally difference from trade as it encourage trade but

ban riba. Moreover, the holy Quran declared that whoever deals with interest is at war

with God and his prophet.115

What is riba?

Surah al-Rum, verse 39 “That which you give as Riba to increase the people’s wealth increases not with God; but that which you give in charity, seeking the goodwill of God, multiplies manifold.” (30: 39)

Surah al-Nisa’, verse 161 “And for their taking Riba although it was forbidden for them, and their wrongful appropriation of other people’s property. We have prepared for those among them who reject faith a grievous punishment.” (4: 161)

Surah Al-e-Imran, verse 130 “O believers, take not doubled and redoubled Riba, and fear Allah so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey Allah and the Prophet so that you may get mercy.” (3: 130)

Surah al-Baqarah, verses 275–281 “Those who take Riba shall be raised like those who have been driven

to madness by the touch of the Devil; this is because they say: ‘Trade is just like interest’ while God has permitted trade and forbidden interest. Hence those who have received the admonition from their Lord and desist, may keep their previous gains, their case being entrusted to God; but those who revert, shall be the inhabitants of the fire and abide therein forever.” (2: 275)

“Allah deprives Riba of all blessing but blesses charity; He loves not

the ungrateful sinner.” (2: 276) 115 V Subbulakshmi, ed, Islamic Banking: An Introduction (Hyderabad: ICFAI Press, 2004) p.36.

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“O, believers, fear Allah, and give up what is still due to you from Riba

if you are true believers.” (2: 278) “If you do not do so, then take notice of war from Allah and His

Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it.” (2: 279)

“And if the debtor is in misery, let him have respite until it is easier,

but if you forego it as charity, it is better for you if you realize.” (2: 280) “And be fearful of the Day when you shall be returned to the Allah,

then everybody shall be paid in full what he has earned and they shall not be wronged.” (2: 281)

In line with the Holy Quran, There are a large number of traditions of the Prophet

(PBUH) available in concern with Riba prohibition. Some example as:

o The holy Prophet (PBUH) announced the prohibition of Riba in express terms at the occasion of his last Hajj, which was the most attended gathering of his Companions. The Prophet said: “Every form of Riba is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting Riba. I start with the amount of Riba which people owe to my uncle Abbas and declare it all cancelled”. He then, on behalf of his uncle, cancelled the total amount of Riba due on his loan capital from his debtors.

o The holy Prophet (PBUH) announced the prohibition of Riba in express terms at the occasion of his last Hajj, which was the most attended gathering of his Companions. The Prophet said: “Every form of Riba is cancelled; capital indeed is yours which you shall have; wrong not and you shall not be wronged. Allah has given His Commandment totally prohibiting Riba. I start with the amount of Riba which people owe to my uncle Abbas and declare it all cancelled”. He then, on behalf of his uncle, cancelled the total amount of Riba due on his loan capital from his debtors.

o Bilal (Gbpwh) once visited the Messenger of Allah (PBUH) with some

high quality dates, the Prophet (PBUH) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of that of the higher quality. The Prophet (PBUH) said: “This is precisely the forbidden Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the others.”

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From the above references, one can see that the Holy Quran and Sunnah

strongly condemn Riba and what constitutes Riba. As it is provided by primary source of

Shariah, there is no argument among Muslims about the prohibition of Riba and all

Muslim sects consider indulgence in Riba based transaction a severe sin. 116

However, the holy Quran did not provide a clear definition of riba. But the basic

rules regarding riba derive from the use of Qiyas (analogy) on several hadith relating to

sale which specifiy that the prohibition extends to gold, silver wheat, barley, dates and

salt.117 So, Riba is prohibited by the holy Quran and Sunnah of Prophet (PBUH) and

defined by Islamic scholars.118

Therefore, arguments rise from the fact that the holy Quran did not provide a

precisely definition of Riba and Qiyas on the meaning of Riba are different. As

Historically shown, debate on topic of what is precisely meaning of Riba has been a main

concern of modern Islamic scholars. Is Riba interest or usurious? If Riba is interest that

mean all extra receipt or payment of money loans are prohibited. While, if Riba simply

mean usurious the most of modern commercial transactions are valid since the rate of

interest have not hit some exorbitant rate.

Although, the liberal scholars try to restrictively define Riba to usurious rates of

interest and tolerates it on the basis of necessity, at least until an alternative financial

Islamic system has been constructed. However, Islamic scholars have yet to reach an

116 Muhammad Ayub, N.110, p.44-46. 117 Abdulkader Thomas, ed, N. 107, p.54. 118 Muhammad Saed Abdul-Rahman, Islam: Questions and Answers v.27, Jurisprudence and Islamic Rulings: Transations-Part 6 (London: MSA Publication Limited, 2007) p.327.

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absolute agreement on the definition of Riba, as the traditional view is that Riba is

interest on loans of money. 119

Riba is Arabic term meaning “an excess, increase, addition, expansion, or

growth”. Technically, it is interpreted by Islamic jurisprudents as “any unjustifiable

increase of capital in loans and sales”. More precisely, it refers to any fixed,

predetermined rate tied to the maturity and amount of principal. So, the general

acceptance among Islamic scholar is that riba covers not only usury but also including all

forms of modern interest as well.120

2.15.2. Prohibition of Gharar

Prohibition of Gharar is the other major prohibition of Islamic finance. Literally,

Gharar is Arabic word meaning risk or hazard. In jurisprudential, there is no precise

definition of Gharar however the term refers to practice of transaction contract which

contain some element of uncertainty or speculation121 Although, Gharar is considered to

be less significance than Riba, in the sense that the involvement of Riba in any degree is

made a transition invalid while the involvement of Gharar will not be made a transition

invalid till the degree of Gharar exceed some acceptable level.122

Traditionally, Prohibition of Gharar is a Islamic rule of trade which dictate that to

valid transaction, contract of any transactions must be free from excessive uncertainty

or doubt about the subject matter, price of commodity, quality, quantity, and deliver

119 Abdulkader Thomas, ed, N. 107, p.53. 120 Hennie Van Greuning and Zamir Lqbal, Risk Analysis for Islamic Banks (Washington, DC: The World Bank, 2008) p.7. 121 Robert F. Cushman, James J. Myers, Construction Law Handbook- v. 1 (New York: Aspen Publishers, 1999) pp.1823-1824. 122 Muhammad Ayub, N.116, p.58.

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date of commodity, a contract of any transaction must not be doubtful or uncertain so

far as the rights and obligations of the contracting parties are concerned. According to

Maliki schools, schools of Islamic though which eminent on the subject of Gharar. The

principles covering Gharar are under the following headings:

i. Gharar in the terms and essence of the contract includes:

a. Two sales in one.

b. Down-payment (Arbun) sale.

c. “pebble”, “touch” and “toss” sales.

d. Suspended (Mu‘allaq) sale.

e. Future sale.

ii. Gharar in the object of the contract includes:

a. Ignorance about the genus.

b. Ignorance about the species.

c. Ignorance about attributes.

d. Ignorance about the quantity of the object.

e. Ignorance about the specific identity of the object.

f. Ignorance about the time of payment in deferred sales.

g. Explicit or probable inability to deliver the object.

h. Contracting on a nonexistent object.

i. Not seeing the object.123

As far as financial trades are concerned ,rule of Gharar will be playing more and

more critical role in many area of Islamic finance in the coming years, particularly in

123 Siddiq Mohammad Al-Ameen Al-Dhareer, Al-Gharar in Contracts And Its Effects on Contemporary Transaction (Jeddah: IRTI, 1997) pp.10-11.

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Takaful operation, the secondary market for Shariah compliant securities and the

possible development of various derivatives in Islamic finance market. There are many

issues rising from the fact that the extent of uncertainty making transaction Haram had

not been clearly defined. Since, risk- taking is rather a part of entitlement of profit in

modern business. Many areas still need Ijtihad to define the difference between Gharar-

e-Kathir (excessive uncertainty) and Gharar Qalil (nominal uncertainty) with the former

is made transaction valid but latter is not. 124

2.15.3. Prohibition of Maisir/Qimar (Games of Chance/ gambling)

Maysir is regarded by most Islamic scholars as gambling or any games of chance.

Both games of chance and gambling are banned by Shariah. As evidence can be

seen from the Holy Quran in chapter 5 verse 90

“O, you who believe! Intoxicants (all kinds of alcoholic drinks), and

gambling, and Al-Ansab (animals that are sacrificed in the name of idols

on their altars) and Al-Azlam (arrows thrown for seeking luck or decision)

are an abomination of Satan’s handiwork. So avoid that (abomination) in

order that you may be successful”

The reasons underlying the prohibition of games of chance and gambling is that

because of the high risk obtaining in these types of transactions. As some people win a

large amount of money, consequently some others will suffer from a loss of their

money, and sometimes face bankruptcy. It leads to financial and societal problems of

124 Muhammad Ayub, N. 116, p.58.

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society. In addition, these games and gambling are unnecessary for society because they

cannot add any surplus to societal wealth. 125

2.16. The evolution of Islamic finance

Although, the evolution of Islamic finance in its modern context appeared at mid

twentieth century. But this does not mean that Islamic finance did not exist before.

Substantial evidence is available that Islamic finance existed since the birth of

Islam in the 6th century. When Muslim traders dominated the world trading, Muslim

traders would engage in financial transaction on the basis Shariah law with principle of

justice of exchange and prohibition of interest and usury. Obviously, their European

counterparts at the time also applied the same principle. The system without interest

which worked on a profit and loss sharing basis was dominantly used over the era

known as the Islamic civilization, from late 6th to early 11th century AD.126

However, Islamic Empire started to decline since 11th century AD. At the same

time, power of western countries was increased on world politics as well as economy.

Since, the superiorities of economic and politics were gradually transferred from the

hand of Muslims to the western who became world dominator. From the mid-

nineteenth century, nearly every Muslim country, stayed under direct or indirect

influence of Western powers. Under western power influence, most countries adopted

western models in all spheres. Therefore, the centuries-old modes of Islamic finance

125 Alsadek H. Gait and Andrew C. Worthington, A Primer on Islamic Finance: Definitions, Sources, Principles and Methods, University of Wollongong School of Accounting & Finance Working Papers Series No. 07/05, 2007. (Wollongong, Australia: School of Accounting & Finance University of Wollongong, 2007) p.11. available at http://ro.uow.edu.au/commpapers/341 126 Dr. Natalie Schoon, Islamic Banking and Finance (London: Spiramus Press Ltd., 2009) p.8.

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were replaced by western financial system which was based on interest payment

philosophy.127

In the modern context, banking is the first mode of finance that Muslim tries to

recover. Although, the concept of banking in which interest is neither charged nor paid

was recognized by group of Muslim businessmen since 1920s,128 but all attempts were

theoretical works.129Until 1950s, the idea was first put into practical action with the

establishment of Farmers Credit Unions in a rural area of Pakistan.130

However, the first highest profile experiment was conducted by The Mit Ghamr

Savings Bank, an Egyptian interest free financial institution, during 1963. The bank

combined the idea of German savings bank with the principles of rural banking within

the framework of Islamic law. However, the success was short and ended in 1967 by

political reasons.131 Compared with its short operation, the success of Mit Ghamr

Savings Bank was impressive as it activities covered 53 town and villages in the Nile

Delta where the people were not familiar with financial institutions. At its peak the bank

had nine branches, 250,000 depositors and nearly two million Egyptian pounds in

deposits.132

127 Abdelkaber Chach,“Origin and Development of Commercial and Islamic Banking Operations” Journal of King Abdulaziz University: Islamic Economics., Vol. 18, No. 2, pp. 3-25,2005, pp.14-15. 128 Israr Hasan, Muslims in America: What Everyone Needs to Know (Bloomington: AuthorHouse, 2006) p.27. 129 Ibrahim Warde, N.113, p.74. 130 Israr Hasan, N. 127, p.27. 131 Ahmed Al- Suwaidi, Finance of International Trade in The Gulf ( London: Graham & Trotman limited, 1994) p.20 132 Ibrahim Warde, N.113, p.73.

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At the same period, Muslim Pilgrims Savings Corporation, well known as Tabung

Hajj or The Pilgrims Management and Fund Board, was established by Malaysia

government as a non-bank financial institution. It main purpose has been to provide

interest-free saving and Halal investment to intending pilgrims.133 It is a saving and

investment organization which collects savings from household, specially saving for hajj

purpose, and invests them. The institution does not give interest of savings but the saver

gets a share in the profit.134

The milestone of Islamic finance can be pinned on the establishment of Islamic

Development Bank (IDB). As a result of the OIC summit in Lahore in 1974, IDB was

established as inter-governmental institution. The new institution aims to promote

Islamic financial industry through direct participation, training and advice, the creation

of new Islamic financial institutions. Subsequently, in 1975 the Dubai Islamic Bank was

created as the first non-government Islamic bank. Before the end of decade, similar kind

of banks sprouted throughout the Islamic world135

In recent years, most Muslim countries and some non-Muslim countries have

inspired the creation of Islamic financial institutions, aiming to pursue the national

interest within financial area. Specially, Malaysia has adopted a new idea of Islamic

financial development. Rather than using what was Islamic acceptable as a starting point

of it Islamic financial development. Malaysians chose to generate new Islamic financial

133 Jamila Hussain, Islam: Its Law and Society ( Sydney: The Federation Press, 2004) p.193. 134 Muhammad Akram Khan, Islamic Economics and Finance (London: Routledge, 2003) p.176. 135 Ibrahim Warde, N.113, p.75.

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innovation with the help of Ijtihad136 of the Malaysian ulema137 in a vast effort to

legitimate modern finance, specially effort on designing interest-free bonds and other

securities. Although, many Malaysian innovations in that area are not deemed

acceptable to Shariah boards in many conservative Gulf States, however these

innovations nourish Islamic financial development particularly in Islamic financial

markets.138

In a nutshell, Islamic finance has emerged from the development of Islamic

banking to a more comprehensive Islamic financial system such as it involves in non-

bank financial institutions, the Islamic interbank money and capital markets and Islamic

insurance. Islamic financial markets are growing significantly due to the development of

supporting financial infrastructure and standardization of international rules and

regulations. Regulatory and legal reforms have been taken place to support the further

development of Islamic finance.

At present, it has become more integrated with the international financial

system. Islamic financial services industry has been experiencing rapidly evolution and

expansion. Its growth is not only in the Muslim world, but across the Western world as

136 Ijtihad ( اجتهاد‎ ) is a technical term of Islamic law that describes the process of making a legal decision by

independent interpretation of the legal sources, the Qur'an and the Sunnah.

137 Ulema ( علماء) refers to the educated class of Muslim legal scholars engaged in the several fields of Islamic studies. They are best known as the arbiters of Shariah law. While the Ulema are well versed in legal jurisprudence being Islamic lawyers, some of them also go on to specialize in other fields, such as philosophy, dialectical theology or Quranic hermeneutics or explanation. In a broader sense, the term Ulema is used to describe the body of Muslim who have completed several years of training and study of Islamic sciences.

138 Ibrahim Warde, N.113, p.85.

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well. Now Islamic finance is no longer service for only Muslims market but is offered in

more than 60 countries with total assets exceeding 500 billion US dollars.139

139 Sohail Jaffer, ed, Islamic Insurance: Trends, Opportunities, and the Future of Takaful (London: Euromoney Institutional Investor Pls, 2007) p.xi.