Islamic Financial Instrument Research Assignment Paper (Research Paper Sample)

Islamic Financial Instrument
Name
Institution
Islamic Financial Instrument
Introduction
Islamic finance is progressively more growing and augmenting its global valuable market on an everyday basis. In recent years, the arrival and rise of Sukuk has been the most important development in the Islamic capital markets. Sukuk is defined as Islamic bonds and signify the comparative ownership of a prevailing asset or a group of diversified assets, and an assurance against prevailing or future cash flows that are generated from these assets for a particular time period. It is a pioneering debt security that is akin to the conventional bond with regard to cash flow and risk. In recent years, this Islamic bond market has experienced a growth rate of roughly 10 to 15 percent. It signifies just about 15 percent of the global Islamic finance asset (Alam et al., 2013). The purpose of this paper is to discuss Sukuk and the Islamic capital markets. It will outline the dissimilarities between Sukuk and conventional bonds, the significance of a capital in an economy, and the investment in Sukuk from the standpoint of the Sharia law.
Purpose and Scope of Study
In recent years, there has been considerable advancement in Islamic Finance. The study focuses on the following issues:
1 The main perceptible differences between conventional bond and Islamic Sukuk.
2 The significance of the capital market to an economy with respect to Islamic Sukuks
3 What is the perspective and stand point of Sharia Law with regarding to investing in Sukuk
4 Theoretical background and the literature review of the different kinds of Sukuk.
5 A reflection of what I have learnt regarding Sukuk and Islamic Finance.
What are the differences between Conventional Bond and Islamic Sukuk
There are particular fundamental differences that exist between Sukuk and conventional bonds. A key aspect of difference lies in the fact that Sukuk follows Sharia law whereas conventional bonds do not follow such rules and regulations. Another key difference between conventional bonds and Sukuk encompasses asset ownership which emanates from the overall structures of the Islamic finance products. In large part, Sukuk holders have ownership of the underlying assets involved in any Sukuk transaction reliant on the magnitude of their investment which ascertains the proportion they are eligible to (Ariff and Safari, 2012). In contrast, the nature of conventional bonds does not permit this sort of ownership taking into account the fact that securities are deemed to be debt obligations. Conventional bonds are simply issued debt obligations to the bold holders by the bond issuer as a form of evidence that the debt does exist. An imperative dissimilarity is that there is now ownership within the business that is transferred to the bold holder. As a result, as for the Sukuk, it signifies a percentage in the business whereas conventional bonds basically signify a portion in the total debt (Ariff et al., 2013). Pricing is another area of difference. On one hand, the pricing of Sukuk is done in accordance to the value of the assets backing them. On the other hand, with respect to conventional bonds, the pricing is centered on credit rating. In addition, Sukuk have the prospect of increasing in value when the assets also increase in value whereas for conventional bonds, the profits generated match up to fixed interest (Yesuf, 2016).
A second key aspect of difference between Sukuk and conventional binds is risk exposure. On one hand, the risk that Sukuk faces fluctuates on the basis of their structure. Moreover, particular kinds of risks are solely applicable to either Sukuk or conventional bond and yet they share certain risks. With regard to Sukuk, the fundamental and significant faced is the breach of standards set by the Accounting and Auditing Organization for Islamic Financial Institutions. On the other hand, conventional bonds are cause to experience different kinds of risk in which a number of these risks are shared by Sukuk. First, financial risk is the risk that there will be failure to pay the interest or face value. This risk can take place in both conventional bonds and Sukuk, but the remedial approaches are dissimilar. With respect to the conventional bond, the bold holders are obligated to resort to the issuer for the amount due. In contrast, Sukuk have recourse on the underlying asset and not to the liquidated individual (Afshar, 2013). Secondly, call risk is the kind of risk in which a bold holder is obliged to sell the unpaid bond back to the bond issuer. With respect to conventional bonds, they are cause to experience this risk when a big market interest takes place. This is an issue as bond holders become disadvantaged from the higher original rate of interest. In contrast, Sukuk is not subject to any variance in the market rates of interests. Third, liquidity risk is the risk that the bond is not marketable at equitable price and time owing to lack or inefficacious secondary market. Both conventional bonds such as municipal and corporate bonds as well as non-tradeable Sukuk (Afshar, 2013).
Why is Capital Market essential to an economy?
In delineation, capital market is the market that permits raising both medium terms and long term finance. The capital market plays a fundamental role in the economy. It offers an assortment of financial instruments that facilitates economic agents in the pooling, pricing and exchanging of risk. By means of assets with appealing yields, liquidity, and risk features, it stimulates saving in a financial form. This is vital for the government in terms of obtaining longstanding funds. As pointed out by Balami (2015), the capital market is a network of specified financial establishments, sequences of mechanism, procedures as well as infrastructure that, in numerous dissimilar manners enable the pool suppliers and users of medium to long-term capital for the investment in various projects for economic development.
Sharia Point of View on Investing in Sukuk
Investment in Sukuk should be compliant with Sharia law. To begin with, the acceptance or payment of interest, also referred to as Riba for investments is absolutely proscribed. In the same manner, the obligation of penalties for lay payments is also forbidden by the law. Secondly, trading under uncertainty in all financial transactions is not allowed. This is because it is deemed to be a zero sum game that bring about imbalanced payoffs. In addition, from the perspective of the Sharia Law, money is no considered to be a financial asset, but simply a medium of exchange and a value metric. Therefore, trading without an underlying asset for anything aside from what is par is not allowed. In addition, Sukuk that encompasses alcoholic beverages, gambling, proscribed drugs are completely forbidden (Howladar, 2009).
Theoretical Background (Literature Review) of the different types of Sukuk
There are two different types of Sukuk, the asset based Sukuk and asset backed Sukuk. For starters, with respect to the asset based Sukuk, the holders of the Islamic bond have beneficial ownership in the underlying asset. This is where particular property rights, for instance, its use and title are in the possession of an individual despite the fact that the legal title of such property belongs to another individual. In particular the Sukuk holders have recourse to the asset originator in the event that there is a deficit or shortage in payments (Afshar, 2013). On the other hand, with respect to the asset backed Sukuk, the Sukuk holders owned the underlying asset and for the reason do not have legal recourse to the asset but rather to the asset originator in the event that there is a deficit or shortage in payment. Another key dissimilarity is that under the asset based Sukuk, in the instance of sales of assets, the investors obtain their face value, and the surplus goes to the originator. In contrast, under the asset backed Sukuk, there is delineation of legal and financial due diligence owing to the reason that investors are compensated from the asset’s cash flow and reclamation. In addition, under the asset backed Sukuk, the Sukuk holders are owners and the assets are considered to be ownership interest. On the other hand, with regard to asset based Sukuk, the assets remain on the financial books of the originator and the Sukuk holders are creditors (Afshar, 2013).
From its inception, the issuance of Sukuk has been done in different nations. To begin with, in the nation of Saudi Arabia, the first issuance of Sukuk raised $9billion. The five-year notes were sold at a rate of 2.93 percent whereas the 10-year notes were sold at a rate of 3.65 perc...