Fundamentals of Islamic Money and Capital Markets

Chapter 10

Islamic Derivatives Market

Learning outcomes

At the end of this chapter, you should be able to:

1 Understand the basic concept of derivatives and derivative markets.

2 Identify the types of players in the derivative markets.

3 Understand the concept of risk in the Islamic perspective.

4 Identify the Islamic alternative for forward, future, swap, and option contracts.

5 Understand the Islamic structure for cross-currency swaps and profit-rate swaps.

6 Understand the concept of Islamic structured products.

Introduction

In this modern world, in which the number of financial transactions is much greater than it was decades ago, there are also greater fluctuations in the prices of assets. The rapid movement of supply and demand for a certain product or financial asset makes the equilibrium price and quantity change very fast. This obviously affects business decisions, particularly due to the involved risk.

There are many types of risk and each company faces risk in a different way from other companies. For example, a company with almost all its assets in equity (and hence with less leverage) would not be exposed to interest-rate risk. The individual who invests in a Shariah-compliant investment may face a rate of return risk. It is a risk that is associated with overall balance-sheet exposures where mismatches arise between asset and balance from fund providers (IFSB2006). For the company that deals with international activities, they need to pay more attention on the exchange-rate ...