Running head: ISLAMIC FINANCE 1

Islamic Finance

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ISLAMIC FINANCE 2

Paper instructions:

Q1) Is Hedging allowed in Islamic Finance?

Conventional finance firms are governed by regulations created by the government of a

particular country while Islamic finance firms have to adhere to both governmental

regulations in a given country and also the Sharia laws. The use of options in the finance

industry as is seen in conventional finance is not acceptable under the Sharia law.

However, when it comes to hedging, the answer cannot be as simple since each situation

is unique. Therefore, hedging can be said to be allowed under Islamic finance when the

economic goals intended to be achieved through hedging have themselves been allowed

under the Sharia law (Smolarski. et al. 2006). A good example of this is when hedging is

used to reduce or avoid unnecessary risk taking. While this may sound similar to

conventional finance practices, it is crucial to note that the objectives, framework, goals,

and even the risks may be defined and determined differently in Islamic finance with

regard to financing practices (Zahan & Kenett, 2012). Therefore, this indicates a

similarity in concept in both systems on the subject but a variation in the execution of the

process in each system.

Q2) Choose the exchange rate of AED vs. other currencies. For instance, Indian;

Pakistan; euro; au$. You mark the exchange rate at 2 different times:

t: 2jan2018, t+l: 20feb2018

i. what if you were an Emarati importer from the above countries? how do you use

forward contract?
ISLAMIC FINANCE 3

Considering that at t: 2nd January 2018 and t: 20th February 2018 are outlined below

respectively

1 USD = 3.6726 AED

1 USD = 3.6723 AED

Considering the above situation, the exchange rate between the US dollar and the AED

appear to be relatively stable. However, since it is difficult to predict this rate in future,

an importer from Emarati could enter into a forward contract with a financial institution

with regard to his/her purchase of the US dollar in future. This measure will ensure that

fluctuations in the exchange rates between the two currencies do not impose a higher

price for the goods to be imported than what was initially expected.

ii. what if you were an Emirati exporter to those above countries? how do you use

forward contracts markets?

Considering that at t: 2nd January 2018 and t: 20th February 2018 are outlined below

respectively

1 AED = 17.2789 PKR

1 AED = 17.6623 PKR

The above rates between the AED and PKR (Pakistan’s currency) indicate variations. For

an Emarati Exporter who has made a future business transaction that is to be paid in

Pakistan’s currency, a forward contract could protect him/her from paying a value higher

than that negotiated. Therefore, I would enter into a forward contract with a bank to

ensure that the exchange rate during the agreed upon business period is similar thus

avoiding to pay more in the event Pakistan’s currency gained on Emarati’s AED.
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References

Smolarski, J. et al. (2006). Permissibility and Use of Options for Hedging Purposes in Islamic

Finance. Thunderbird International Business Review, Vol. 48(3), pp. 425-443. Retrieved

from. ierc.sbu.ac.ir/.../Article/Permissibility%20and%20Use%20of%20Options%20for

%20H...

Zahan, M. & Kenett, R. (2012). HEDGING INSTRUMENTS IN CONVENTIONAL AND

ISLAMIC FINANCE. Electronic Journal of Applied Statistical Analysis: Decision

Support Systems and Services Evaluation (EJASA:DSS), Vol. 3(1), pp. 59-74. Retrieved

from. siba-ese.unile.it/index.php/ejasa_dss/article/viewFile/11306/11158