Islamic Capital Markets

A comprehensive examination of Islamic capital markets Taking a comparative approach to the subject, this text looks at the similarities and differences between Islamic capital markets and conventional capital markets. The book explains each particular topic from both the conventional and the Islamic perspective, offering a full understanding of Islamic capital markets, processes, and instruments. In addition to a full explanation of Islamic products, this approach also ensures a holistic understanding of the dual markets within which Islamic capital markets operate. Ideal for both students and current practitioners, The New Islamic Capital Markets fills a large gap in the current literature on the subject. Whereas most books in this field cover the topic only superficially, this book offers the depth of coverage and academic rigor needed by professionals and serious students. Fills a gap in the current literature on the subject with comprehensive coverage and in–depth explanations Takes a comparative and holistic approach to the subject and features case studies from Malaysia, Indonesia, the Middle East, and Europe Written by a professor of finance at the International Centre for Education in Islamic Finance (INCEIF) One of the few comprehensive, dedicated guides to the subject available, The New Islamic Capital Markets offers a full understanding of the subject for students and professionals alike.

Preface xv Acknowledgments xvii CHAPTER 1 Founding Thoughts—Adam Smith, Capitalism, and Islamic Finance 1 Introduction and Overview 1 Chapter Topics 1 Chapter Objective 2 Key Terms 2 1.1 The Roots: The Economy, Real and Financial Sectors, Risk and Islamic Finance 2 1.2 Uncertainty and Risk 3 1.3 Why Is There Uncertainty and Risk? 4 1.4 Types of Risk 5 1.5 Risk in the Real Sector and in the Financial Sector 5 1.6 Financial System of Capitalism: The Foundations 6 1.7 Smith and Arrow 7 1.8 Smith and Ethical Rules 8 1.9 An Arrow–Debreu Economy 9 1.10 What Happened to the Smith–Arrow Risk–Sharing Ideal? 10 1.11 Can Economics Explain a Positive Predetermined Rate of Interest? 11 1.12 Islamic Finance: The Foundations 13 1.13 Islamic Rules Governing Exchange 15 1.14 Islamic Financial Markets and Instruments 20 1.15 Islamic Finance Industry at Present 22 1.16 What Does the “Paper Economy” Look Like Today, Some Five Years After the Crisis? 23 Summary 24 Questions and Problems 25 References and Further Reading 26 CHAPTER 2 The Capital Markets 37 Introduction and Overview 37 Chapter Topics 37 Chapter Objective 37 Key Terms 38 2.1 Introduction 38 2.2 Key Trends in Capital Market Development 41 2.3 Stock Exchanges of the Islamic World 45 2.4 The Debt Markets 50 2.5 The Money Markets 53 2.6 The Derivatives Market 53 2.7 Risks in Capital Markets 57 Summary 61 Questions and Problems 61 References and Further Reading 62 Websites 62 CHAPTER 3 Islamic Finance: Underlying Philosophy, Contracts, Instrument Design, and Requisites 63 Introduction and Overview 63 Chapter Topics 63 Chapter Objective 63 Key Terms 64 3.1 Introduction 64 3.2 Underlying Themes and Fundamentals of Fiqh Mu’amalah 66 3.3 Requirements for Islamic Capital Market Instruments/Transactions 66 3.4 Shariah–Based Contracts for Financial Transactions 68 3.5 International Regulatory Institutions for Islamic Finance 77 Summary 79 Questions and Problems 80 References and Further Reading 80 Websites 81 CHAPTER 4 The Interbank Money Markets 83 Introduction and Overview 83 Chapter Topics 83 Chapter Objective 84 Key Terms 84 4.1 Introduction 84 4.2 Money Market—Components 87 4.3 Money Market Instruments 90 4.4 The Pricing of Money Market Instruments 93 4.5 Determining the Yield of a Money Market Instrument 95 4.6 Interest Rates, Yields, and Price of Money Market Instruments 95 4.7 Malaysia Money Market—Trading Performance 97 4.8 The Central Bank, Money Market, and Monetary Policy Operations 100 4.9 Commercial Banks and the Money Market 102 Summary 105 Questions and Problems 106 References and Further Reading 106 Websites 107 CHAPTER 5 The Islamic Interbank Money Market (IIMM) 109 Introduction and Overview 109 Chapter Topics 109 Chapter Objective 110 Key Terms 110 5.1 Introduction 110 5.2 The Islamic Interbank Money Market 112 5.3 Pricing the Mudarabah Interbank Investment Funds 113 5.4 The Islamic Interbank Cheque Clearing System (IICCS) 115 5.5 Islamic Money Market Instruments 115 5.6 Key Islamic Money Market Instruments 115 5.7 Pricing of Islamic Money Market Instruments 122 5.8 The Islamic Interbank Money Market and Issues of Risk 122 5.9 Trading Performance on IIMM 124 5.10 The Kuala Lumpur Islamic Reference Rate (KLIRR) 125 5.11 The Bursa Suq al Sila (BSaS) 128 5.12 The Commodity Murabahah 129 5.13 The Liquidity Management Centre (LMC) 131 Summary 133 Questions and Problems 134 References and Further Reading 135 Websites 135 CHAPTER 6 Bonds and Bond Markets 137 Introduction and Overview 137 Chapter Topics 137 Chapter Objective 138 Key Terms 138 6.1 Introduction 138 6.2 Bank Borrowing versus Bond Issuance 139 6.3 Debt versus Equity and Bond Features 141 6.4 Face Value and Par Value 142 6.5 The Pricing of Bonds 145 6.6 Bond Yields and Yield Curves 147 6.7 Yield Curve and Credit Spreads 148 6.8 What Constitutes a Yield? 149 6.9 Interest Rate Change, Bond Yields, and Duration 151 6.10 Risks Associated with Bonds 158 6.11 Types of Bonds 159 6.12 Bond Ratings 166 6.13 Ratings and Yield/Credit Spreads 167 Summary 168 Questions and Problems 168 References and Further Reading 169 CHAPTER 7 Sukuk and Sukuk Markets 171 Introduction and Overview 171 Chapter Topics 171 Chapter Objective 172 Key Terms 172 7.1 What Are Sukuk? 172 7.2 Sukuk Fundamentals 174 7.3 Underlying Islamic Contracts for Sukuk 176 7.4 Sukuk Structures 178 7.5 Sukuk Players 186 7.6 Risks Associated with Investing in Sukuk 187 7.7 Sukuk in Malaysia 191 7.8 Sukuk in Malaysia: Growth and Evolution 194 7.9 Underlying Asset and the Structuring of Sukuk 195 7.10 The Pricing of Sukuk 201 Summary 207 Questions and Problems 208 References and Further Reading 209 CHAPTER 8 Common Stocks and Equity Markets 211 Introduction and Overview 211 Chapter Topics 211 Chapter Objective 212 Key Terms 212 8.1 Introduction 213 8.2 The Evolution of Stocks 214 8.3 Why Companies Choose to List 217 8.4 Rights of Share Ownership 218 8.5 Equity Ownership and Shariah Compliance 219 8.6 The Valuation of Common Stocks 221 8.7 The Market Required Rate of Return 229 8.8 The Required Return and the Stock Price Dynamics 230 8.9 Dividend Growth and the Trade–off with Capital Gains 231 8.10 Stock Market Indices 235 8.11 Schools of Thought on Stock Price Behavior 236 Summary 243 Questions and Problems 244 References and Further Reading 245 CHAPTER 9 The Islamic Equities Market 247 Introduction and Overview 247 Chapter Topics 247 Chapter Objective 247 Key Terms 248 9.1 Introduction 248 9.2 Components of an Islamic Equities Market 249 9.3 The Screening of Stocks for Shariah Compliance 249 9.4 Components/Products of an Islamic Equities Market 254 9.5 Islamic Equity Indices 267 9.6 The Stock Exchanges of the Islamic World 269 Summary 272 Questions and Problems 273 References and Further Reading 274 Websites 274 CHAPTER 10 Derivative Instruments: Products and Applications 275 Introduction and Overview 275 Chapter Topics 275 Chapter Objective 276 Key Terms 276 10.1 Introduction 277 10.2 What Are Derivative Instruments? 277 10.3 Common Derivative Instruments 278 10.4 The Evolution of Derivative Instruments 279 10.5 Forward Contracts 280 10.6 The Need for Futures Contracts 280 10.7 The Need for Options 282 10.8 Options: Key Features and Trade–offs 283 10.9 Payoffs and Risk Profiles of Option Positions 284 10.10 Interest Rate Swaps (IRSs) 291 10.11 The Main Players in Derivative Markets 294 10.12 Commodities versus Financial Derivatives 295 10.13 Derivative Markets and the Role of the Clearinghouse 296 10.14 Applications: Using Derivatives to Manage Risk 297 10.15 What Derivative to Use? 303 10.16 Overview of Global Derivatives Trading 303 Summary 308 Questions and Problems 309 References and Further Reading 310 Websites 311 CHAPTER 11 Shariah–Compliant Derivative Instruments 313 Introduction and Overview 313 Chapter Topics 313 Chapter Objective 314 Key Terms 314 11.1 Introduction 314 11.2 Necessary Features for Islamic Financial Instruments 315 11.3 Islamic Finance Instruments with Features of Derivative Instruments 315 11.4 The Islamic Profit Rate Swap (IPRS) 321 11.5 How Is the IFI Hedged? 323 11.6 Sukuk with Embedded Options 323 11.7 Contemporary Derivative Instruments—How Shariah Compliant Are They? 324 11.8 Shariah–Compliant Instruments for Managing Exchange Rate Risk 328 Summary 329 Questions and Problems 330 References and Further Reading 331 Website 331 CHAPTER 12 Exchange Rates and the Foreign Exchange Market 333 Introduction and Overview 333 Chapter Topics 333 Chapter Objective 334 Key Terms 334 12.1 Introduction 334 12.2 What Is an Exchange Rate? 335 12.3 Exchange Rate Risk 337 12.4 The Foreign Exchange Market 341 12.5 Foreign Exchange Market Players 345 12.6 Spot and Forward Markets 347 12.7 Bid–Ask Spreads 348 12.8 Cross Rates 349 12.9 The Forward Market for Exchange Rates 350 12.10 Forward versus Spot Rates 350 12.11 Forward Market Players 351 12.12 Nominal versus Real Exchange Rates 355 12.13 Shariah–Compliant Techniques for Managing Currency Exposure 356 Summary 360 Questions and Problems 361 References and Further Reading 363 Websites 363 CHAPTER 13 Capital Markets and Government Policy 365 Introduction and Overview 365 Chapter Topics 365 Chapter Objective 365 Key Terms 366 13.1 Risk Sharing 366 13.2 Islamic Finance and Risk Sharing: Role of Public Policy 377 Questions and Problems 391 References and Further Reading 392 Index 403