islamic derivatives 2
TRANSCRIPT
Islamic derivativesPresented by Syed Taha ali
Group 2
Financial derivativesSBP defines derivatives in Financial Derivatives Business Regulations (FDBR) as “a type of financial contract the value of which is determined by reference to one or more underlying assets or indices.”
The major categories of such contracts include forwards, futures, swaps and options.
Characteristics of derivatives
• Financial derivatives are financial instruments that derive their value from another transaction.
• Initial investment is very low or zero.• Settled at a later date.
Fundamental isues:
• Inexistence of contract.• Lack o f actual ownership• Lack of delievery.• Prohibitions of riba.• Prohibitions of gharar(uncertainity).• Prohibitions of maysir(gambling).• Bai ul kali bil kali.• Finally, jahl refers to ignorance.
Guidance From Quran on Business Dealings:
• أن إال بالباطل بينكم أموالكم التأكلوا آمنوا الذين أيها يامنكم تراض عن تجارة .تكون
اآلية( – النساء، ).29سورة• “O Ye who believe! Eat not up your property among
yourselves unduly. Let it be trade amongst you by mutual agreement”.
• This verse is perhaps the most important verse of Quran on economic matters. It tells us both the do’s and the don’ts in business dealings.
• First the don’ts.
What is Allowed in Business Contracts
• The Golden Principle of Free Choice
• حالال حرم أو حراما حلل شرطا إال شروطهم عند المسلمون
• “Muslims are free to determine the conditions of their contracts unless they make something forbidden as permissible or something permissible as forbidden”
• In Islamic theory of contracts, parties are free to agree on any terms as long as known Islamic rules and principles are not violated.
Prohibition of Gambling (Maysar)
• يا أيها الذين آمنوا إنما الخمر والميسر الشيطان فاجتنبوه واألنصاب واألزالم
لعلكم تفلحون رجس من عمل• O Ye who believe, Intoxicants and Gambling,
(Dedication of ) stones, And (Dedication of) arrows, are an abomination, of Satan’s handiwork: Eschew such (abomination) , That ye may prosper.
• Gambling amounts to transfer of wealth without any value added.
Guidelines for Islamic Financial derivative Contract Design
• Freedom in determining the conditions of a contract within Shariah rules.
• Prohibition of taking others’ property without compensation.
• Conscious Agreement within Shariah limits.• Mutual Benefit (Value Equivalence).• Justice and Fairness (Elimination of Exploitative
Clauses).• Provision of Maximum Possible Information.• Honoring the Spirit of Contract.
Islamic derivatives
• Islamic option model based on khyar bil shart (conditional option).
• Islamic Profit rate swaps.• Wa’ad contracts.
Islamic option model based on khyar bil shart (embedded conditional option).
• Independent financial contract that are traded for a price have no clear-cut parallel in the classical Islamic theory of contracting.
• The informationally disadvantaged party at the time of entering into the contract has the option to cancel the contract within a specified time period.
• A person has also the right to undo his purchase if the seller specifically allows as part of the sale.
• Khiyar relates to a halal contract of exchange that has already taken place, whilst a modern option relates to an exchange that is yet to take place.
• Premium charged under share options is not allowed.
• In case of khiyar , the exchange of one or both counter values is effected immediately while in case of modern option contract future delivery apply to both payment and underlying asset.
PROFIT RATE SWAP• In PRS, only cash flow is changed. This cash flow
is in the same currency. Therefore, the exchange involved is to change the flow of the fixed profit rate with the floating profit rate.
• In the present Islamic profit market, there are two variations or structures employed byIFI’s:
a) PRS based on waad and murabahah principles.b) PRS based on waad and musawamah
principles.
ISLAMIC PROFIT RATE SWAP
Objectives of IPRS
To match funding rates with return rates
To achieve lower cost of funding To restructure existing debt profile To manage exposure of KIBOR or LIBOR To deepen Islamic Financial Market
Receives fixed returns
THE DYNAMICS OF IPRS
ABCABCFinancial Liabilities
Financial Liabilities
Financial Assets
Financial Assets
Islamic Swap Counter PartyIslamic Swap Counter Party
Receives floating profit rate
Pays floating obligations
Pays fixed profit rate
STAGE 1: Fixed Profit Rate
ABCABC
Islamic Swap Counter PartyIslamic Swap Counter Party
ASSET
STEP 1 ABC sells Asset to
Islamic Swap counter Party at notional
principal of RM500k.
STEP 2Islamic Swap Counter
Party sells Asset to ABC at notional principal RM500k + mark-up
based on fixed profit rate
STEP 3Notional principal
amount of RM500k owed by both ABC and Islamic Swap
party to each other is set off
STEP 4 The net difference i.e. the
fixed profit rate in Step 2 is paid to Islamic Swap
counter Party by ABC at the agreed interval
payment date of say 6 month
STAGE 2: Floating Profit Rate
STEP 1 ABC sells Asset to
Islamic Swap counter Party at notional
principal RM500k + floating profit rate.
STEP 2Islamic Swap counter
Party sells Asset to ABC at notional
principal of RM500k.
STEP 3Notional principal
amount of RM500k owed by both ABC and Islamic Swap
party to each other is set off
STEP 4 The net difference i.e. the floating rate profit in Step
1 is paid to ABC by Islamic Swap counter
Party at the agreed interval payment date of
say 6 month
ABCABC
Islamic Swap Counter PartyIslamic Swap Counter Party
ASSET
STAGE 3 – Determination of Subsequent Floating Rate
Floating Profit Rate (Stage 2) is repeated every 6 months until maturity.
6 MONTHS 6 MONTHS 6 MONTHS 6 MONTHSMATURITY
ABCABC
Islamic Swap Counter PartyIslamic Swap Counter Party
ASSET
CONTRACT OF WA’AD:• A “promise” thus is non-binding. It is also
unilateral therefore both parties can choose not to make good their promise.
• Under Shariah because of the unilateral nature of the promise, the details of the promise are not as carved in stone as any other contract. Those restrictions donot apply to the contact of wa’ad.