Académique Documents
Professionnel Documents
Culture Documents
Finance – An Overview
1
What are derivatives?
A derivative security is a financial asset whose value is
dependent on the value of an underlying asset. The
underlying asset could be a basic financial asset like
common stocks, bonds, currencies or commodities.
Since by this definition, a derivative is a "claim on a
claim" the value of the derivative will depend on the
value of the asset (stocks, bonds, etc) on which it has a
claim.
Common forms : Forwards, Futures, Options, Swaps.
Also, exotics like, Swaptions; LEAPs, CMOs etc.
At a basic level; derivatives enable the avoidance of
unnecessary risks.
2
Evolution of Derivative Markets/Instruments
Futures Contracts
Options
Financial Engineering
Exotic Options
Synthetic Instruments
Swaps etc.
3
Rationale: Why do we need derivatives?
As with any other financial product, derivatives were the result of financial
innovation. Innovation that responded to the existing need to help manage
risk in increasingly sophisticated business environments.
While forward contracts were originally innovated for risk-management of
agro-based products, the later instruments were needed as risk environments
changed.
Each step down the evolutionary chain; added value.
Forward Futures; reduced
• Liquidity risk
• Counterparty risk
• Avoid price squeeze etc.
Futures Options
• Increased flexibility
• Ability to take advantage of favourable price movts (unlike lock-in)
*managing contingent claims/liabilities.
6
Off Balance Sheet
Forwards; Short FC forward contracts.
Futures; Short FC futures contracts.
Options; Long FC Put Options.
Swaps; FC payer, HC receiver
Off Balance Sheet techniques have become
tremendously popular;
Cheap and flexible
No inconvenience to customer
Can enhance competitiveness
9
Futures Contracts and Islamic Finance
A number of instruments/contracts exist in Islamic finance
that could be considered a basis for forward/futures
contracts within an Islamic framework.
10
Ba’i Salam
Salam is essentially a transaction where two parties agree to carry
out a sale/purchase of an underlying asset at a predetermined
future date but at a price determined and fully paid for today
This is similar to a conventional forward contract however, the big
difference is that in a Salam sale, the buyer pays the entire
amount in full at the time the contract is initiated. The contract
also stipulates that the payment must be in cash form.
The idea behind such a ‘prepayment’ requirement has to do with
the fact that the objective in a Ba’i Salam contract is to help needy
farmers and small businesses with working capital financing.
Since there is full prepayment, a Salam sale is clearly beneficial to
the seller. As such, the predetermined price is normally lower
than the prevailing spot price.
This price behavior is certainly different from that of conventional
futures contracts where the futures price is typically higher than
the spot price by the amount of the carrying cost.
11
The lower Salam price compared to spot is the “compensation” by
the seller to the buyer for the privilege given him.
12
It should be clear that current exchange traded futures
would conform to these conditions with the exception of the
first, which requires full advance payment by the buyer.
13
The
The Salam
Salam Contract
Contract &
& Islamic
Islamic Financial
Financial
Institutions
Institutions
14
(I)
(I) Parallel
Parallel with
with Seller
Seller
Here, the bank which had gone into an original Salam Contract
enters into a contract promising to sell the commodity to a third
party on the delivery date.
Since this is not a Salam Contract the bank does not receive
advance payment.
16
Istisna and Joala Contracts
The price for the product is agreed upon and fixed. While the
agreement may be cancelled by either party before production
begins, it cannot be cancelled unilaterally once the manufacturer
begins production.
17
Unlike the Salam Contract, the payment
here is not made in advance. The time of
delivery too is not fixed.
18
The
The Bai’bil-wafa
Bai’bil-wafa &
& Bai
Bai ‘bil
‘bil Istighlal
Istighlal Contracts
Contracts
The Bail bil-wafa is a composite of bai (sale) and rahnu (pledge).
Under this contract, one party sells an asset to a buyer who pledges to sell
back the asset to the original owner at a predetermined future date.
The rahnu (pledge) being to sell back to the owner and not to a third party.
Looks like a REPO? Except that the resale price must be the same as the
original purchase price.
But like a REPO, the buyer has rights to benefits from ownership of the
asset.
The Bai bil-Istighlal is really a combination of the Bai wafa and Ijarah.
20
Overview
Overview of
of Istijrar
Istijrar
The Istijrar involves two parties, a buyer which could be a company
seeking financing to purchase the underlying asset and a financial
institution.
22
PLB P0 P* PUB
24
Payoff
Payoff to
to Istijrar
Istijrar
If Pt upper bound
25
FUQAHA (JURISTS)
VIEWPOINTS ON
CONVENTIONAL
DERIVATIVE INSTRUMENTS
26
Futures
1) Fatwa of Omam Al-Haramaini Al-Jauwaini
Options have generally been examined under the fiqh doctrine of al-
khiyarat (contractual stipulations) or under the bai-al-urbun concept.
Urbun being a transaction in which a buyer places an initial good faith
deposit.
29
2) Abu Sulayman (1992) (Fiqh Academy – Jeddah)
Acceptable when viewed in the light of bai-al-urbun
but considers options to have been detached and
independent of the underlying asset – therefore:
unacceptable.
3) Mufti Taqi Usmani (Fiqh Academy – Jeddah)
Promises as part of a contract is acceptable in
Shariah, however the trading and charging of a
premium for the promise is not acceptable.
Yet others have argued against options by invoking
“maisir” or unearned gains. That is, the profits from
options may be unearned.
30
4) Hashim Kamali (1998)
Finds options acceptable
Invokes the Hanbali tradition
Cites Hadiths of Barira (RA) and Habban Ibn
Munqidh (RA).
Also draws parallels with the al-urbun in arguing that
premiums are acceptable.
Also cites that contemporary scholars such as Yusuf
al-Qaradawi and Mustafa al-Zarqa have
authenticated al-urbun. (similar stand by Iranian
scholars)
31
5) Shariah Advisory Council; Securities
Commission
Though no formal opinion on stock or Index Options,
the SAC has allowed other option-like instruments.
Warrants
TSRs
Call Warrants
32
Conclusion
The overall stance of Fuqaha, of conventional derivative
instruments appears to be one of apprehension even suspicion.
That these instruments could easily be used for speculation
appears to be the key reason for objection.
That derivatives form the basis of risk-management appears to
have been lost.
Key Problem: Evaluation has always been from a purely juridical
viewpoint. And like most juristic evaluation, have relied on
precedence? But there isn’t a precedence nor equivalence for
the kind of risk-management problems faced today.
When extrapolating/inferring : template may be wrong.
The object of juridical analysis appears to be a micro
examination of each and every feature of a derivative instrument
to see if it passes, a often subjective religious filter.
33
The overall intended use of the instrument nor the
societal benefits that could accrue do not seem to have
been given due consideration.
Aside from individual interpretation, the differing
opinions among mazhabs/imams complicates the
situation further. Thus, an options contract may be
found objectionable for exactly opposite reasons.
While some mazhabs like the Hanbalis have been
broader in their acceptance, the Shafi’ and Hanafis
have been less so. The Hanbalis for example are
somewhat liberal when it comes to Option of stipulation
(Khiyar-al-Shart).
The Hanbalis hold that stipulations that remove a
hardship, fulfills a legitimate need, provide a benefit or
convenience, or facilitate the smooth flow of commercial
transactions are generally valid as a matter of principle.
34
Obvious need for a more coordinated
evaluation; need based rather than purely
juristic/precedent driven.
35