Fundamentals of Islamic Money and Capital Markets

Mohd Azmi Omar, PhD, is the Director General of the Islamic Research & Training Institute (IRTI), Islamic Development Bank. He was formerly the Deputy Rector (Deputy Vice–Chancellor) in charge of academics and research at the International Islamic University Malaysia (IIUM). He obtained his bachelor′s and master′s degrees in finance from Northern Illinois University, USA, and his PhD from Bangor University, United Kingdom. Muhamad Abduh is the Head of Research of IIUM′s International Institute of Islamic Business and Finance (IIiBF) and the editor–in–chief of its official journal, the Journal of Islamic Finance. Dr. Raditya Sukmana is an Assistant Professor in the Department of Islamic Economics, Airlangga University, Surabaya, Indonesia. He obtained his BA in finance from Airlangga University; an MS in economics from Georgia State University, USA; and a PhD in Islamic finance from International Islamic University Malaysia in 2010.

Preface xiii


Acknowledgments xv


1 An Introduction to Conventional and Islamic Financial Systems 1


Learning Outcomes 1


Introduction 2


The Roles and Functions of Financial Markets 4


Structures of Financial Markets 6


Based on the Instrument 6


Based on the Issuance of Securities 8


Methods Used in Secondary Markets 8


Based on the Maturity 9


Classification of Financial Markets 9


The Money Market 10


The Capital Market 12


Types of Financial Intermediaries 13


Depository Institutions 14


Contractual Institutions 15


Investments and Finance Institutions 17


A Brief Overview of the Islamic Financial System 17


Evolution of Islamic Finance 18


Chapter Summary 20


Chapter Questions 21


Notes 22


References 22


2 Development of Islamic Capital and Money Markets in Malaysia 23


Learning Outcomes 23


Introduction 24


Development of Islamic Financial Institutions in Malaysia 24


1960 to 1990: Establishment of Islamic Financial Institutions 24


1990 to 2000: Conventional Banks Allowed to Offer Islamic


Financial Products and Services 26


2000 to 2010: Islamic Subsidiaries and the International Integration of the Islamic Banking System 27


Islamic Capital Markets in Malaysia 29


Sukuk 30


Islamic Collective Investments 31


Islamic Stock Broking 32


Malaysia International Islamic Financial Centre (MIFC) 33


Chapter Summary 34


Chapter Questions 36


Notes 36


References 36


3 Regulators and Transactions Platform for Capital and Money Markets 37


Learning Outcomes 37


Introduction 38


Bank Negara Malaysia (BNM) 38


Role and Functions 39


BNM Administered Legislation 40


Role of BNM on ICM Development 42


The Securities Commission (SC) 42


Role of SC on ICM Development 42


Bursa Malaysia (BM) 45


Role of BM on ICM Development 45


Shariah–Compliant Stocks and ETF 46


Islamic Equity Indices 46


Islamic REITs and Sukuk Market 47


Chapter Summary 47


Chapter Questions 48


Notes 48


References 48


Websites 48


4 Islamic Money Market 49


Learning Outcomes 49


Introduction 50


Money Market Participants 50


Functions of the Islamic Money Market 51


Differences between Islamic and Conventional Money Markets 52


Components of the Malaysian Islamic Money Market 53


Islamic Interbank Market 53


Mudarabah Interbank Investment 54


Profit Calculation for Mudarabah Interbank Investment 55


Example: Mudarabah Interbank Investment (MII) 56


Commodity Murabahah 56


Example: Commodity Murabahah Interbank Investment 58


Wakalah Investment 58


Trading of Islamic Money Market Instruments 59


Government Investment Issue (GII) 60


Example: Calculation of GII price 61


Malaysian Islamic Treasury Bills (MITB) 61


Example: Calculation of Proceeds on MITB 62


Bank Negara Monetary Notes (BNMN) 62


Sukuk Bank Negara Malaysia Ijarah (SBNMI) 63


Islamic Negotiable Instruments (INI) 63


Negotiable Islamic Debt Certificate (NIDC) 63


Example: Calculation of Price of NIDC of Less Than One Year 64


Example: Calculation of Price NIDC with Maturity of More Than One Year 65


Islamic Negotiable Instruments of Deposit (INID) 66


Example: Calculation of Proceeds for an INID 66


Islamic Accepted Bill (IAB) 67


Import and Local Purchases 67


Export/ Local Trade 67


Example: Price Calculation of IAB under Bai al–Dayn 68


Sell and Buy Back Agreement (SBBA) 68


Example: Sell and Buy Back Agreement 69


Cagamas Sukuk 70


Sanadat Mudarabah Cagamas (SMC) 70


Example: Sanadat Mudarabah Cagamas (SMC) Calculation 71


Sanadat Cagamas 71


Islamic Corporate Sukuk 72


Chapter Summary 72


Chapter Questions 73


Notes 73


References 74


5 An Overview of Sukuk 77


Learning Outcomes 77


Introduction 78


Comparing Sukuk, Bonds, and Shares 79


Sukuk Types 81


Sukuk Structures 81


Sukuk al–Ijarah 82


Sukuk al–Musharakah 88


Sukuk al–Mudarabah 94


Sukuk al–Salam 99


Sukuk al–Istisna 102


Sukuk al–Murabahah 106


Sukuk al–Istithmar 110


Sukuk al–Wakala 114


Chapter Summary 117


Chapter Questions 118


Notes 118


References 119


6 Shariah–Compliant Equity 121


Learning Outcomes 121


Introduction 122


The Structure of Equity Markets 124


Shariah–Compliant Equity Securities 125


Differences between Shariah and Non–Shariah–Compliant Equity Markets 128


Shariah–Compliant Stocks Screening 130


Malaysia Securities Commission 130


S&P Shariah Indices 131


Pakistan Meezan Islamic Fund 133


Global GCC Islamic Fund Screening 134


Jakarta Islamic Index 135


Chapter Summary 136


Chapter Questions 136


Note 136


References 136


7 Islamic Mutual Funds 139


Learning Outcomes 139


Introduction 140


Closed and Open–Ended Funds 140


Conventional Mutual Funds 141


Active and Passive Management 143


Advantages of Mutual Funds 143


Disadvantages of Mutual Funds 144


Fees and Expenses 145


Islamic Mutual Funds 146


Basic Concept of Islamic Mutual Funds 147


Shariah Stock Screening 147


Purification of Income 148


Types of Islamic Mutual Funds 149


The Role of the Shariah Advisory Board in Islamic Mutual Funds 151


Calculating NAV in the Islamic Mutual Funds 151


Organisation of Islamic Mutual Funds 153


The Process of Investing in Islamic Mutual Funds 154


Islamic Ethical Investment and Ethical Investment 156


Chapter Questions 158


Notes 158


References 158


8 Islamic Real Estate Investment Trusts (I–REITs) 161


Learning Outcomes 161


Introduction 162


Islamic Real Estate Investment Trusts (I–REITs) 165


Shariah–Permissible Investments for I–REITs 166


I–REITs Structure 169


Case Study: Al–’Aqar KPJ REIT 171


Case Study: Al–Hadharah Bousted REIT 174


Difference between Conventional and Islamic REITs 176


Chapter Summary 177


Chapter Questions 178


Notes 178


References 178


9 Islamic Exchange–Traded Funds 179


Learning Outcomes 179


Introduction 180


Open– and Closed–End Funds, and Unit Trust Funds 180


Open–End Funds 180


Closed–End Funds 181


Unit Trust 181


Exchange–Traded Funds (ETFs) 181


Islamic Exchange Trade Funds (I–ETFs) 185


Security Borrowing and Lending in Malaysia 190


Islamic ETFs in Other Countries 195


Challenges in Promoting I–ETFs 195


Chapter Summary 196


Chapter Questions 197


Notes 197


References 197


10 Islamic Derivatives Market 199


Learning Outcomes 199


Introduction 200


Derivative Securities in the Conventional Market 200


Risk Profile 202


Main Players in the Derivative Markets 203


Hedging with a Forward Contract 204


Hedging with Future Contracts 205


Hedging with Swap Contracts 206


Derivative Securities in the Islamic Perspective 211


Islamic Forward and Future Contract 213


Islamic Option Contract 216


Islamic Cross–Currency Swap 218


Islamic Profit Rate Swap 220


Islamic Structured Product 222


Chapter Summary 225


Chapter Questions 226


Notes 226


References 227


Bibliography 229


About the Authors 233


Index 235