Answers

TOPIC 1: INTRODUCTION TO ISLAMIC FINANCE Self-Test 1

1. Islam prohibits riba (interest) as practiced in conventional finance and banking operations. Riba is the single most important feature that distinguishes Islamic finance and banking from conventional one. Other core Shariah proscriptions are Gharar (deception or ignorance in transactions through non-disclosure or non-availability of the full facts relevant to any party or the whole transaction) and investment in a range of banned activities such as casinos, gambling, armaments, pornography, breweries, and interest-based financial services. Definition: (a) Fard or Wajib An obligatory duty, the omission of which is punishable. (b) Mandub or Mustahab An action which is rewarded, but the omission is not punishable. (c) Jaiz or Mubah An action which is permitted, and the law is indifferent. (d) Makruh An action which disliked yet not punishable, but the omission is rewarded. (e) Haram An action which is absolutely forbidden and punishable. The Islamic resurgence in the late 1960s and 1970s has initiated the call for a financial system that allows Muslim to transact in a system that is in line with their religious beliefs. Al-Quran; Al-Sunnah; Itjmak Ulama and Qiyas (analogical deduction).

2.

3.

4.

Self-Test 2
1. History of Islamic finance and banking, theoretical framework of Islamic finance and banking, Riba, Gharar, profit sharing, Islamic ethics in economic activities.

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129

2.

(a) (b)

Shariah Islamic jurisdiction based on Al-Quran and Al-Sunnah Riba Interest - Money paid for the use of money lent (the principal), or for forbearance of a debt, according to a fixed ratio. Usury The practice of lending money at interest; especially in the practice of charging, taking or contracting to receive, excessive or illegal rates of interest for money on loan.

(c)

Muamalat The conduct of a Muslims economic activities within his economic system. Al-Musyarakah Profit sharing between partners and between investor and entrepreneur (trust financing)such as share financing, unit trust financing, bridging finance, syndicated financing, bonds, letters of credit. Al-Qardul Hassan Benevolent loan (charity) Should be used for: Working capital financing; Goodstanding bank customers and has problem in cash flow, charge card, bonds, government investment issues.

(d)

(e)

3.

Ethics is the essence of Quranic teaching. Ethics is a study about morality and conduct. The Quranic ban on riba is made on the basis of justice and equity, both of which are important ethical precepts.

4. Careers in Islamic Finance and Banking

(a) (c) (e) (g)

Executive in corporate sector Administrator in government sector Economic analyst Bank officer

(b) (d) (f) (h)

Entrepreneur Insurance/Takaful executive Financial officer Researcher in Islamic finance and banking

5.

Issues: (a) (b) (c) The overall availability of Islamic financial and capital market products and services; The regulatory framework applied to Islamic financial services and products, and issues pertaining to compliance and investor protection; The state ofIslamic capital market development including an examination of growth factors and impediments;

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(d) (e)

Market foundations frameworks; and

such

as

accounting

standards

and

tax

International issues relating to cooperation and collaboration efforts among jurisdictions, as well as efforts to address differing interpretations among scholars.

TOPIC 2: INTRODUCTION TO RIBA Self-Test 1

1. Riba An-Nasiah Time that is allowed the borrower to repay the loan after its due date. In return the borrower must pay the additional or premium for the extension in duration. i.e. Interest on lent money or capital. Riba Al-Fadl This is riba which occurs as a result of trade or sale transactions. Taking a superior thing of the same kind of goods by giving more of the same kind of goods of inferior quality, e.g., dates of better quality for dates of inferior quality in greater amount. 2. Give example of: (a) (b) Riba An-Nasiah If a person lend RM1,000 to you, and ask for RM100 extra upon returning the loan, that RM100 is clearly riba. Riba Al-Fadl If one kilogram of dates of high quality, are exchanged on the spot with two kilograms of poor quality dates, then this is riba al-fadl.

3.

Two examples of revelation in Al-Quran regarding prohibition of riba: And for their taking interest even though it was forbidden for them, and their wrongful appropriation of other peoples property. We have prepared for those among them who reject faith, a grievous punishment. (4:161). O believers, take not doubled and redoubled interest, and fear God so that you may prosper. Fear the fire which has been prepared for those who reject faith, and obey God and the Prophet so that you may receive mercy. (3:130-2)

4.

List the rationale for prohibition of riba. (a) (b) (c) Riba as an unearned income. Riba also is a form of exploitation to the poor people. Riba as a mechanism of inequitable redistribution of wealth.

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131

(d) (e) (f) 5.

Riba is a form of discounting the future that lead to the economically rational. Extinction of a species. Riba as an agent of economic instability.

Three examples of hadith that condemn riba: (a)

God would not allow four persons to enter paradise or to taste its blessings: he who drinks wine, he who takes riba, he who usurps an orphans property without right and he who is undutiful to his parents. Gold for gold, silver for silver, wheat for wheat , barley for barley, dates for dates and salt for salt like for like, equal for equal and hand to hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand to hand.
And also narrated by Talhah Ibn Ubaydullah: Umar Ibn Khattab said that, the Prophet said:

(b)

(c)

If you wil sell gold for silver, then there is a danger of interest in it. If you sell wheat for wheat, barley for barley and adates for dates, the result would be no different; except that the exchange be spot.
6. Four advantages of having riba-free in the business context: (a) Profit-sharing helps allocate resources efficiently, as the profit-sharing ratio can be influenced by market forces so that capital will flow efficiently. More emphasis on ethical and moral system that goes beyond the interaction of factors of production and economic behavior can ensure equality and fairness for the good of society. Social and religious issues will be an important contribution to international business ethics, for it is supported by a general crosscultural moral belief that the poor ought to be protected. Help to create the culture which share certain moral principles like beneficence, truthfulness and fairness which regulating morally responsible merchant-consumer relationship.

(b)

(c)

(d)

Self-Test 2
1. Riba means to increase (al-ziyada), to grow (al-numuw), to multiply, to expand, to rise and to become lofty (al-irtifa and al-uluw). From the Shariah (Islamic law) point of view, riba technically refers to the premium that

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must be paid by the borrower to the lender along with the principle amount as a condition for the loan or for an extension on its maturity. 2. (a) Debt riba This is refers to the payment of goods using through longer installment period and smaller installment amount, at the end of the period, results in the total amount being more compared to the original price (lump sum payment in cash). The difference between instalment price and original price is clearly debt riba. Trade riba This is riba arising from unequal value of hand-to-hand purchase and sale of commodities. It covers all spot transactions involving cash payment on the one hand and immediate delivery of the commodity on the other. Riba al-fadl is the interest that is overcharged or surplus, when one party demands an additional increase to the counter-value.

(b)

3.

In order to avoid riba in trade and business, any profit sought by Muslims should be through their own exertion and not through exploitation of others or at the expense of others. The following fiqh rules apply: a) which means does the capital owner has to choose, either a return on his capital by sharing with its user in profit, or a guarantee to repay his capital intact. A return and guarantee on capital can not be combined together in one deal. And b) which means that the capital owner will be entitled to, profit only if he is ready to accept loss if this happened. These rules are the basis of all profit and loss sharing financing methods in Islam and they leave no doubt that interest paid to bank depositors above their money, or interest paid by borrowers from banks for the use of banks money is riba. The prohibition of riba is important because: (a) (b) Placing interest in juxtaposition with wrongful appropriation of property belonging to others. Many verses in Al-Quran are Allahs word that condem those who take riba and this indicate the seriousness a felony of taking interest in the eye of The Almighty. Riba is essentially in conflict with the clear and unequivocal Islamic emphasis on socio-economic justice. In banning riba, Islam looks towards establishing a society based upon fairness and justice. Loan provides the lender with a fixed return irrespective of the result of the borrowers scheme. It is more reasonable to have a sharing of the profits and losses.

4.

(c) (d)

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5.

Riba Free society can be achieved if we follow the following steps: (a) (b) Always fear Allahs command in The Al-Quran [2:279]. Use Profit-sharing basis as an alternative to interest (Riba). It is permissible in Islam over interest is that in the case of the former it is only the profit-sharing ratio, not the rate of return itself that is predetermined. Profit-sharing helps allocate resources efficiently, as the profit-sharing ratio can be influenced by market forces so that capital will flow into those sectors which offer the highest profit-sharing ratio to the investor, other things being equal. Create more public awareness such as active campaigning to make people realise what the Islamic system is, through education, information, media, government policies and agencies, scholars both religious and professionals - all of them have to play their part in that. Government should focuses on the economic and financial aspects of transactions through the Islamic system which places equal emphasis on the ethical, moral, social, and religious dimensions, to ensure equality and fairness for the good of society as a whole.

(c)

(d)

(e)

TOPIC 3: ISLAMIC FINANCING INSTRUMENTS Self-Test 1

1. The fundamental difference from a legal point of view is the central role of revelation in Islamic law. It is based on the general rule. No ruling based on legal reasoning is allowed where a ruling exists in a Legal Text (Nas) in the Quran or Hadith. 2. Some of the more popular instruments in Islamic financial markets are

Trade with markup or cost-plus sale (murabahah). One of the most widely
used instruments for short-term financing is based on the traditional notion of purchase finance. The investor undertakes to supply specific goods or commodities, incorporating a mutually agreed contract for resale to the client and a mutually negotiated margin. Around 75 percent of Islamic financial transactions are cost-plus sales.

Leasing (ijara). Another popular instrument, accounting for about 10

percent of Islamic financial transactions, is leasing. Leasing is designed for financing vehicles, machinery, equipment, and aircraft. Different forms of leasing are permissible, including leases where a portion of the installment payment goes toward the final purchase (with the transfer of ownership to the lessee).

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Profit-sharing agreement (mudarabah). This is identical to an investment

fund in which managers handle a pool of funds. The agent-manager has relatively limited liability while having sufficient incentives to perform. The capital is invested in broadly defined activities, and the terms of profit and risk sharing are customized for each investment. The maturity structure ranges from short to medium term and is more suitable for trade activities.

Equity participation (musharaka). This is analogous to a classical joint

venture. Both entrepreneur and investor contribute to the capital (assets, technical and managerial expertise, working capital, etc.) of the operation in varying degrees and agree to share the returns (as well as the risks) in proportions agreed to in advance. Traditionally, this form of transaction has been used for financing fixed assets and working capital of medium- and long-term duration.

Sales contracts. Deferred-payment sale (bay' mu'ajjal) and deferred-delivery sale (bay'salam) contracts, in addition to spot sales, are used for conducting
credit sales. In a deferred-payment sale, delivery of the product is taken on the spot but delivery of the payment is delayed for an agreed period. Payment can be made in a lump sum or in installments, provided there is no extra charge for the delay. A deferred-delivery sale is similar to a forward contract where delivery of the product is in the future in exchange for payment on the spot market. 3. In order for the Islamic Financing Instruments contracts to be islamically lawful contracts, the contracts must: (1) be mutually consented by both parties, the buyer and the seller, (2) avoid four main elements of prohibitions which are namely interest(riba), uncertainty (gharar), gambling (maysir) and other prohibitions, and (3) have a lawful contractual objectives.

Self-Test 2
1. Since Islamic financing system is backed by assets, it is always matched with corresponding goods and services. While conventional financing system deals with interest bearing loan, time due of money and no risk is assumed. Usufruct (the right to use the object) for a specified period of time. The sale of usufruct is permissible in Islam, as evidenced by the verses 26-27, chapter 28. It is also evidenced by the following hadith narrated by Ahmad, Abu Dawud, and An Nasai on the authority of Saad (r.a.):

2.

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135

The farmers during the time of the Prophet (s.a.w) used to pay rent for the land in water and seeds. He (s.a.w.) forbade them from doing that, and ordered them to use gold and silver (money) to pay the rent.
3. There is nothing to prevent the bank from buying the goods for itself, or from selling them to another by acting as the exporters agent. When the bank buys the goods for itself it will have the right to sell them to any of its clients by means of murabaha or musawamah (a sale of bargaining), for cash or credit. The source of this ruling is the verse in the Quran that says: Allah has made sales lawful, but has prohibited riba (2:275).

TOPIC 4: ZAKAT IN ISLAM Self-Test 1

1. Zakat is a levy imposed divinely on Muslims. Islamic scholars debate whether it ought to be described as a "tax". However, zakat should be regarded more appropriately as a religious levy by which Muslims "make over part of their wealth for the needs of others" - a sentiment consistent with the literal meaning of zakat - "to grow and to purify". Definition to these words: (a) (b) (c) (d) (e) 3.

2.

Haul The goods were kept in a full year possession period Nisab The required amount that entitle for zakat payment Asnaf The list of people who are entitled to receive zakat Fisabilillah
The people who stirve in the cause of Allah

Amil The people who responsible to collect zakat

Zakat payments, including zakat fitrah dan zakat from earnings are usually made during the month of Ramadan. There are several conditions for assesment of zakat before zakat payment is calculated. The main conditions for zakat include: (a) (b) (c) (d) (e) (f) (g) Muslim Wise Genuinely owned Productive assets Surplus assets Full years possession (Haul) Fullfil the nisab

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4.

The recipient of zakat is also known as asnaf. They are: (a) The hardcore poor or fakir. (b) The needy who need help to supplement their income and life. (c) The travellers or musafir for religious or spiritual purposes. (d) The reverts or muallaf. (e) The debtors (on the edge of financial disaster). (f) The slaves who desire for freedom. (g) The amil or zakat collector. (h) The people who strive in the way of Allah (fisabililah). There are two types of calculating zakat for earnings: (a) Urfiiyah Method (Capital Growth) Current capital = Owners Equity + Debt Financial Capital + Profit Fixed Asset Other Non Current Assets. Syariiyah Method (Working capital ) Net Current Asset = Current Asset (full ownership) Operating Liability only. Current

5.

(b) (c)

However, there are certain conditions that assets can be exempted from zakat. These include: Non productive fixed, non current asset, asset which are not fully owned by the owner, current operating liability, fund for charity, net receivables after zakat deduction and any receivables from HARAM sources. 6. Three benefits of zakat. (a) (b) (c) The socio economy in the country will be balanced, and encourage the rich to help the poor continuously. Zakat is the backbone of Muslim nation's financial system that keeps money in circulation. Zakat also discourages hoarding and protect the muslims from many other vices, as love of wealth is the root of many immoral actions.

7.

Zakat on agriculture is referred to the obligation of the owner the staple foods of the particular countries which fulfill the nisab and haul. Some examples of the zakatable grains are paddy, dates, corn, wheat etc. The staple food for Malaysia is rice and rice comes from paddy. Thus, paddy farmer need to pay the zakat on paddy, when it fulfills the nisab and haul. The nisab is 5 ausuk or equivalent to 363 gantang in Malaysia. The haul is equivalent to one full year ownership. The grains or fruits must be planted

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by the farmers. The farmers need to pay the 5% zakat rate on agriculture after grains have been harvested.

Self-Test 2
1.

Zakat al-Fitr or fitrah refers to the obligation of every Muslim (except those
who are absolutely destitute) to contribute a certain amount of staple food or pay an equivalent monetary amount in the month of Ramadan before the Muslim festive celebration or Eid al Fitr.

2. 3.

The hardcore poor or fakir. There are two types of zakat in Islam: (a) (b) Zakat fitrah (al-Fitr) A flat fee or levy imposed on each person. A religious levy on wealth (Ariff, Zakat from earnings (al-Mal) 1991).

4.

The difference between zakat fitrah and zakat from the income such as salary and dividends:

Zakat al-Fitr or fitrah refers to the obligation of every Muslim zakat al-Fitr
flat fee is one sa` a little more than two kilograms of wheat, barley, dates, or rice or the monetary equivalent. All Muslims must pay zakat al-Fitr for themselves and their dependents. Income refers to earnings from salary, dividends or other receivables income from services or consultation. Salary is paid as a reward for completion of services or work in the companies or institutions. There are 3 ways to calculate zakat on income: (a) 2.5 % on the total annual gross income (if the total income is more than the nisab rate). The total annual gross income is RM33,800.00. The zakat is RM33,800.00 x 2.5 % = RM845.00. Zakat is paid after deducting all allowable basic expenses. Zakat is paid after deducting all the liabilities.

(b) (c) 5. 6.

The normal rate for zakat is 2.5 %. There are many debate from different ulama on how to determine the amount of zakat payable at the end of the zakat period.

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ANSWERS

Malikis and Shafiis calculate the nisab at year's end only. Hanafis, however, calculate the nisab at the beginning and the end of a year, and zakat is payable if the nisab is reached at either of those two points. Generally, at assessment date, a Hanafi business owner would add holdings of "cash in hand," "cash at bank," the value of "inventories of finished goods" and other productive property, and "net realizable receivables," and then pay a zakat of 2.5 percent on the balance in excess of the nisab. Conventionally, zakat is levied on all physical and monetary items of wealth that conform to the zakat prescription.

TOPIC 5: Self-Test 1
1.

SHIRKAH

The difference between Shirkah al-Milk and Shirkah al-aqd: Shirkah-al-milk: This refers to joint ownership or co-ownership of an asset. For example we may choose to open a joint bank account or a husband and wife may decide to jointly own a house they are buying. This type of partnership is not necessarily meant for business purpose. Shirkah-al-aqd: This refers to a partnership formed via a mutual contract. It is also known as joint commercial enterprise. This partnership carries the same connotation like in the conventional organisation where group of individuals share the capital and profit.

2.

Identify whether true or false: (a) (b) (c) (d) (e) T F F F T Abu and Bakar contributed capital of RM 40,000 each to start an Inan partnership. They agreed to share the profit according to a ratio of 70:30. Allowed. In Inan partnership they are free to contribute any capital and share profit according to any ratio. Abu and Bakar contributed capital of RM 40,000 each to start a Mufawadah partnership. They agreed to share the profit according to a ratio of 70:30.

3.

(a)

(b)

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Not allowed. Mufawadah partnership requires not only equal capital but also equal PSR. (c) Khairul contributed RM 30,000 and Amani contributed RM 60,000 to start an Inan partnership. They agreed to share the profit equally. Allowed. In Inan partnership they are free to contribute any capital and share profit according to any ratio. Khairul contributed RM 30,000 and Amani contributed RM 60,000 to start a Mufawadah partnership. They agreed to share the profit equally. Not allowed. Mufawadah partnership requires equal capital. Jack joined Victor and Knight Partnership with a capital contribution of RM35,000. Victor and Knight guaranteed that Jack would enjoy 8% return on his capital every year. Not allowed. Jack could not enjoy a guaranteed return in a partnership contract according to the Islamic law. This would result in Riba. Abdullah and Nur Jannah formed a partnership with a capital of RM15,000 each. They however did not agree on any profit sharing ratio. Not allowed. PSR must be agreed upon upfront. If no ratio is agreed, the contract is not valid in Shariah.

(d)

(e)

(f)

Self-Test 2
1. Ahmad and Idham contributed capital of RM 40,000 and RM 60,000 to start a new partnership. Required: (a) Say the partnership formed is Inan Partnership. Profit earned was RM50,000. How would you divide this profit between the partners according to the: (i) (ii) Capital Ratio. Agreed ratio assume they agree to share the profit equally.

(iii) How would the answer in (ii) above change if the ratio agreed was 1:3?. Ratio i. Capital (2:3) ii. Equal Ahmad =50,000 x (2/5) =20,000 =50,000/2 Idham =50,000 x (3/5) =30,000 =50,000/2

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(b)

=25,000 =25,000 iii. Ratio 1:3 =50,000 x (1/4) =50,000 x (3/4) =12,500 =37,500 Say the partnership formed is Mufawadah Partnership. Profit earned was RM50,000. How would you divide this profit between the partners according to the: (i) (ii) Capital Ratio. Agreed ratio assume they agree to share the profit equally.

(iii) How would the answer in (ii) above change if the ratio agreed was 1:4?.

First of all, this partnership would not qualify for a Mufawadah partnership because the capital is not equal. Therefore, the partnership will automatically convert to Inan partnership and the answer to the question would be the same as in Question 1 above.
(c) Say the partnership formed is Inan Partnership. The partnership experienced a loss of RM35,000. The agreed ratio was 7:8. How will the loss be distributed between the partners? Ratio Capital (2:3) Ahmad =35,000 x (2/5) =14,000 Idham =35,000 x (3/5) =21,000

2.

Adibah provided RM10,000 to Nor to start a Mudharabah partnership and agree to share profit according to the ratio of 40:60. Following are results of the business performance. How would it be distributed between Adibah and Nor? Year 1: Loss Year 2: Profit Year 3: Profit = RM 1,000 = RM 4,000 = RM 6,000 Adibah (40) 1,000 (Rabb al-Maal absorb loss) = 4,000 x 0.4 = 1,600 = 6,000 x 0.4 = 2,400 Nor (60) NIL = 4,000 x 0.6 = 2,400 = 6,000 x 0.6 = 3,600

Profit or loss Y1: Loss RM1,000 Y2: Profit RM 4,000 Y 3: Profit RM 6,000

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141

3.

Compare between General Investment Account (GIA) and Special Investment Account (SIA). GIA GIA is based on Al-Mudharabah Al-Mutlaqah (Unrestricted Mudharabah) where the depositor does not have the option to set any condition to the banks investment policy. GIA depositors have lower investment amount and are offered standard investment scheme and fixed PSR. SIA SIA is based on Al-Mudharabah AlMuqayyadah (Restricted Mudharabah) where the depositors could set conditions on the banks investment policy. SIA requires higher minimum investment amount and this in turn gives the SIA depositors the ability to negotiate the PSR with the banks.

4.

Double Mudharabah is like sub-leasing or sub-contracting, where the entrepreneur that received the Mudharabah capital, gives this money to another entrepreneur in a second Mudharabah agreement. It is applied in the banking industry like the following: Depositors give money to the bank on Mudharabah basis (Depositor = Rabb al-Maal, Bank = Mudarib). Bank extends this fund to its clients that need financing to operate their business. (Bank = Rabb al-Maal, Client = Mudarib).

TOPIC 6: Self-Test 1
1. 2. 3. 4. B C C A

OTHER FINANCIAL INSTRUMENTS

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5.

List two Natural Certainty Contracts and two Natural Uncertainty Contracts. NCC Murabahah Ijarah Salam Istisna NUC Musharakah Mudharabah

6.

The difference between Murabahah and Murabahah made to order: Murabahah: bank is the vendor and has ready stocks of commodity with it. Murabahah made to order: bank does not have ready stocks of commodity and only purchases inventory when the customers places order.

7.

AITAB is: Al Ijarah Thumma Al-Bai (Lease then sale). It is a form of finance lease where the client first leases the asset. At the end of the lease, the client then purchases the asset from the lessor.

Self-Test 2
1. The return to the financier under NCC is pre-determined. It is certain. Thats why these instruments are called debt-based instruments. The bank enjoys a pre-determined return that has no corelation with the performance of the user of finance. The difference between Murabahah and Ijarah: Murabahah Ijarah

2.

Ownership is transferred to the Does not transfer ownership to the client on the day of the sale client - the bank (the lessor) is the owner and it only transfers the usufruct to the client. Price must be fixed at the time of The rentals could be flexible and sale and cannot be changed reflect the changing economic and thereafter. business condition.

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143

3.

No. Payment for Istisna contract can be very flexible. Total payment can be done upfront or at the end. Payment could also be arranged in installments either through out the construction period or it could extend beyond the construction period. From Day 1 until maturity, the bank is the owner of the asset. Only at maturity, ownership transfers to the client. The clear identification of owner/user is very important liabilities and risks of ownership must be borne by the owner (lessor). This means that the owner (the lessor i.e. the bank) must pay for insurance and maintenance of the asset. The lessee is only liable to the expenses regarding the usage of the asset.

4.

5.

(a)

Salam financing:

(i) (ii)

Salam is equivalent to a forward sales and is usually utilised for agricultural products. Being a forward sale, total payment must be made upfront so that the client may utilise the sale price as capital to start his project.

(b)

Steps involved: (i) (ii) Abu sells 1 tonne of Misai Kucing to the Islamic bank at a price of RM 20/kg (any price below the market price). Therefore the bank paid the total selling price (RM20 x 1,000 kg = RM20,000) to Abu on Day 1.

(iii) Abu can use this money to start his project. (iv) After 6 months Abu will delivere 1 tonne of Misai Kucing to the Islamic bank. 6. Parrallel Istisna could be utilised to finance a house under construction: (a) (b) Client asks the bank to construct a house for him with clear specification. The cost to construct the house is RM250,000. The bank agrees and signs an Istisna contract with the client. (The bank is the seller in the first Istisna. The selling price that the bank charges is RM350,000 Cost of construction plus profit to the bank). The bank then finds a contractor for the construction and asks him to handle the project.

(c)

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(d)

The contractor agrees and signs an Istisna contract with the bank. (Now the contractor is the seller in the second Istisna. The contractor charges the full construction cost). Upon completion, the contractor delivers to the bank and the bank delivers to the client.

(e)

TOPIC 7: DISCOUNTING IN PROJECT EVALUATION: AN ISLAMIC PERSPECTIVE Self-Test 1

1. Discounting, in finance, means that we are discounting our cash flow. Discounted cash flow is what someone is willing to pay today in order to receive the anticipated cash flow in future years. The prevention of Israf (waste) is an important Islamic goal which favours efficiency. Islamic uneasiness about discounting rise from its alleged connection with interest. If the project is discount at an interest rate, it should be rejected. Islam places high premium on economic justice by eliminating interest or riba. The rate of return on equity is the proper discount rate in uncertain worlds. A Muslim is permitted to choose only Halal investments, and out of several Halal investments, he can choose the one which gives a higher return. 3. Discounting which is based on positive time preference is considered to be a risk aversion behaviour. It seems to be a normal human behaviour where people naturally discount future consumption. If the marginal utility of future goods is lower, because of their increased provision, present goods must be preferred. If a person is asked to sacrifice present consumption in return for extra consumption in future, he would discount it. However, a consumer may have a positive or a negative time preference. Those who expect fluctuation in income may have negative rates of time preference among some time periods.Thus, time preference cannot provide a rational for always discounting future cost and benefits in project evaluation.

2.

Self-Test 2
1. The net marginal product of investment are realised through time, probabilistic (risky or uncertain) and positive (expected value and positive net marginal product). If the resources are received earlier in a project,

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more opportunity to be invested longer. Therefore, it will be more productive on average. Discounting the project is an application of the concept of opportunity cost of investing resources over time. The magnitude or the extend of discounting should be related to marginal product of the possible investments having a similar degree of uncertainty. 2. In the conventional system, under the weighted average cost of capital (WACC) method, the methods normally being used are weighted average cost of debt and weighted average cost of equity. But, from Islamic view, no debt is allowed if involved riba and, thus no weighted average cost of debt. Only weighted average cost of equity is allowed. Therefore, with this justification, the required rate of return should be determined instead of the rate of interest. Main argument against time value of money is that this concept is valid only for the goods being consumed in the present (at this very moment) and not for those goods which are not being consumed i.e. future goods. (See details in Akram Khan). Assumption of Certainty It is unrealistic to assume perfect foresight. Example of false assumption is excess profits disappear in the long run. Actually, there is still uncertainty of generating excess profits in future. In Islam, it is stated in the Quran that No soul knowth what it will earn tomorrow And, in Surah Al-Araaf (7:188) Had I knowledge of the unseen, I should have abundance of wealth, and adversity would not touch me Based on these verses in the Al-Quran above, itt is clear that Islam emphasizes that there is uncertainty about future consequences of present actions. 3. At present, the discount rate is used in different contexts where in the world of perfect certainty, both rates (interest rate) i and (rate of return) r are considered identical and being used interchangeably. While in the world of uncertainty, both rates i and r are treated differently. i is treated as the rate of interest and r is treated as the rate of return. Only r or the rate of return is allowed in discounting activity from the Islamic view. It is proper to use the compound interest table (periodic growth table). There is no contradiction and no connection to interest. It is simply a mathematical expression of quantity that grows or declines regularly.

4.

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ANSWERS

TOPIC 8: ISLAMIC FINANCIAL MARKET Self-Test 1

1. Trading of Shariah-compliant securities is for Muslims and non-Muslims investors. Definitions: (a) (b)

2.

Shariah-compliant

Activities conform to the Shariah criteria established by the SAC.

Islamic Capital market The market where the activities are carried out in ways that do not conflict with the conscience of Muslims and the religion of Islam. Non-Shariah-compliant Activities not conform to the Shariah criteria established by the SAC.

(c) (d) (e)

Shariah index

The index serves to guide Muslims investors especially to buy shares that are Shariah-compliant.

Islamic financing Financing of business operation using Shariahapproved financing products.

3.

Muslims investors invest in Shariah-compliant securities because they seek to invest in securities and instruments which are in line with Shariah principles. Three reasons why investing in Bursa Malaysia is permissible by Shariah are with regard to the limited companies formed under the Companies Act 1965: (a) (b) (c) Their form; The terms of issue of their shares; and The rights and responsibilities of the shareholders of their shareholders are similar to the criteria of Inan company recognised by Shariah, with the only exception of the unlimited liabilities of the shareholders involved in the management of the company.

4.

ANSWERS

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Self-Test 2
1. Other Shariah-approved instruments are Sukuk, Islamic unit trusts, Shariah indices, warrants (TSR), call warrants and Crude Palm Oil futures contract. Definitions: (a) (b) (c) (d) (e) Shariah-based unit trust funds approved securities. Non-halal products Funds that are invested in Shariah-

2.

Such as pork and its related product, liquor. Trading activities that are

Commerce as a matter of morality accordance to ethics and morality.

SAC screening methodology Selection criteria or requirements to approve securities as Shariah-compliant. Good image Such as hotel that holds bad image because they sell alcohol and promote prostitution but if a hotel is operating without the elements of alcohol and prostitution that would bring a good image.

3.

Islamic stockbroking - BIMB Securities deals with buying and selling activities of Shariah-approved stocks only. To improve acceptance of Islamic financing and investment products: (a) (b) (c) Awareness programs. School and higher learning institutions curriculum. Government support.

4.