Global Financial Crisis and Risk Management in Islamic Finance

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					  SUKUK: CASH FLOW & VALUATION
                     THEORIES

                M. Ariff & Shamsher M
               Bond University Australia &
                University Putra Malaysia


DIFC: 3-5-10
             VALUATION THEORIES
   A: DEFINITION & PRINCIPLES
      WHAT IS A SUKUK SECURITY?

      PRINCIPLE OF OWNERSHIP-BASED CLAIM VS A
       CLAIM FOR LENDING (INTEREST CLAIM)
   B: WORLD MARKETS FOR FUNDS
       SHARE MARKET FUNDS        VS MUSHARAKA
       BILLS & BOND MARKET FUNDS VS MURABAHA & MUDARABA &
                                    ISTISNA
       DERIVATIVE MARKET SIZE    VS SALAM
   C: CASH FLOW PATTERNS
       TERM OF CONTRACT              FIXED VS VARIABLE VS GROW
       ASSET-BACKING CASH FLOW       RISK-SHARING
   D: VALUATION THEORY BUILDING
       SO FAR NOT PUBLISHED AS SOLUTIONS
       COULD WE DO IT? MUST WE NOT DO IT? Does IF need Valuation?
CONCEPT DEVELOPMENT FOR VALUATION
         THEORY-BUILDING
                 CONVENTIONAL SECURITIES


                   RESIDU
        EQUITY     AL
                   OWNER

                                           DELAY
                            FUTURES        ED      DERIVATIVES
                                           OWNE
                    RIGHT                  RSHIP
         DEBT       TO
                    INTER
                    EST




                       A SIMPLISTIC VIEW
                                                           4
DIFC: 3-5-10
       CONVENTIONAL FUNDS MARKET SIZE


                                     US$ 45,000 BIL EQUITY




                                     US$ 154,000 BIL DEBT




                                     US$ 644,000 BIL FUTURES



SOURCE: ARIFF et al. (forthcoming)
    ISLAMIC: CONCEPT OF OWNERSHIP VITAL
                     CONCEPT OF OWNERSHIP IS
O
  EQUITY   MUSH      CENTRAL IN ISLAMIC SECURITIES
W
N          ARAKA
E                    BEYOND EQUITY-TYPE SECURITIES
R
S                    NO SECURITY CREATED WITHOUT
H                    OWNERSHIP. CLAIM-BASED FUNDING
I          MUDAR
           ABA &     IS NOT SAME AS OWNERSHIP-BASED
P DEBT
           IJARA
           ISTISNA   TENOR IS CONTRACTUAL
C
E
N                    PAYMENT TERMS ARE CONTRACTUAL
T
A                    INFINITE VS FINITE VS FIXED VS
L FUTURE   SALAM     FLOATING VS PAR VS MORE THAN
                     PAR
          ISLAMIC FUNDS MARKET SIZE


           US$ ??? BIL MUSHARAKA?
EQUITY     DON’T KNOW!
           PERHAPS ABOUT 40% OF $45,000?
           WE JUST ACCEPT ISLAMIC INDEX FIRMS

           US$ ??? “DEBT” LIKE INSTRUMENTS?
SUKUK      DON’T KNOW?
           LESS THAN US$ 100 BIL (LESS THAN 1%)

          US$ ??? BIL FUTURES?
FUTURES   DON’T KNOW?
          MINISCULE?
CASH FLOW PATTERNS
SECURITISATION ISLAMIC SECURITY
            COMPLEXITY BECAUSE
            OF OWNERSHIP                       O
                                 FIXED
                                               W
                                               N
                                               E
               INCOME                          R
    IN         STREAM             VARIABLE
    NEED
                         SVP
                                               O
    OF
                                               F
    FUNDS

               FACE              PAR           F
               VALUE             VALUE?        U
                                               N
                                               D
                                               S


       CASH FLOW OF FUNDING FOR PROFIT SHARE
    RECOGNISING CASH FLOW PATTERNS
   QUESTION OF TENOR?
       CONVENTIONAL EQUITY (INFINITE)
       MUSHARAKA
            (ACTIVE PARTNERSHIP) INFINITE VS DIMINISHING SUKUK (TERM)
       MUDARABAH; IJARA; ISTISNA: FINITE TENOR
       SALAM CONTRACT FINITE TENOR
   QUESTION OF PROFIT-SHARES
       ALL ARE “VITALLY” PROFIT-SHARED
       APPEARANCE OF FIXED REWARDS
   FIXED VS VARIABLE VS GROWTH VS DEPRECIATION
       SIMPLE (IJARA) IS FIXED “APPEARANCE”
       VARIABLE RETURNS BASED ON LIBOR+ OR KLIBOR+
       FIXED PAR AT END OF TENOR
       PAR CAN BE HIGHER AT END !
BASIC PATTERNS OF CASHFLOWS
                         FIXED

A

                        BALLOON



B
                        GROWING
              …………….

C

                        VARIABLE

D
    BASIC PATTERNS TO DEVELOP
            THE MATHS
   A PATTERN IS EASY TO DEVELOP THE MATHS
     BUT PAYOFF COMES FROM SVP, SO IS SVP
       EARNINGS MAY BE STOCHASTIC
   B PATTERN APPEARS SIMPLE
       WHAT IS SVP INCOME STREAM?
       HOW MUCH IS THE END PAYMENT PROFIT SHARE?
   C PATTERN HAS A GROWTH COMPONENT
       THIS PRODUCES A MORE COMPLEX MATHEMATICAL
        SOULUTIONS
       WHERE THRE IS GROWTH IN SVP, THER IS LIKELY TO BE A
        DEPRECIATION AS SVP PHYSICAL ASSETS HAVE DECLINE
   D PATTERN IS MORE COMPLEX AS IT CAN ONLY BE
    PREDICTED BY INTEREST RATE THEORIES!!
       CONSTANT PART IS EASY TO VALUE.
BASIC MATHEMATICS FOR CLOSED FORM
            SOLUTIONS
CF


     FIXED, NOT STOCHASTIC FINITE
                TENOR

             (1   )   N
                              1
                               
                              
                  P
        +
              (1   ) n
       GROWTH MATHS



         (1  h)  1
                  n            n
                                      (1  g ) 
                                              t
(1 + h)                =                   t
         h                  t 1    (1   ) 

               (1  g )t 
Where (1+h) =            
               (1   )t 
1
2
    VARIABLE MATHS IF STOCHASTIC


         ln( S / X )   F T
    d1 =                     σ√T;
                T
       d2 = d1 - σ√T
  DEPREIATION & CONVERSION
MORE COMPLEX INSTRUMENTS POSE MORE
COMPLES SOLUTIONS

EXAMPLE: CONVERTIBLE SUKUK WILL NEED
BOTH A FIXED VALUATION AND A STOCHASTIC
VALUATION

SIMILARLY, A SVP WITH DEPRECIATING
PROPERTY VALUE, WILL HAVE A GROWTH AND
DEPRECIATION COMPONENT

IN SHORT SUKUK POSES VALUATION
COMPLEXITY. WE ARE WORKING SEVERAL BASIC
MODELS TO REOLVE THIS
VALUATION CHALLENGES
          VALUATION CHALLENGES
   THIS PRESENTATION SHOWS COMPLEXITY OF
    VALUATION MODELS FOR SUKUK
   THE OWNERSHIP BEFORE LENDING INTRODUCES
    FUNDAMENTAL DIFFERENCE IN ISLAMIC FINANCE
   THAT IS OPERATIONALISED AS SVP OR SOME FORM
    OF PROFIT SHARED RETURNS
   HENCE, THERE IS STOCHASTIC FLOWS PROBLEMS
   HENCE THERE IS FINITE VS INFINITE SUMS MATHS
    NEEDED
   HENCE, GROWTH POSES A CHALLENGE FOR
    MODELING
   PROFIT SHARE POSES A PROBLEM FOR SOLUTION
   VALUATION IS NEXT FRONTIER OF ISLAMIC
    FINANCE                                19
                Work in progress: Not to be cited




               Thank You

DIFC: 1-5-20

				
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