The Islamic Financial System 127
of the security will depend on the expected market value of the asset at the
time of maturity of the security.
Finally, due to multiple layers of origination and credit enhancements,
the risks are transferred to a third party in the event of a default. The risk
sharing is minimized and investors are protected from the performance of
underlying assets but are still exposed to the creditworthiness of the guar-
antor. In an asset - linked security, the price of the security will incorpo-
rate the riskiness of the underlying assets and the investor will be sharing
TABLE 6.1 Comparison of conventional and Islamic securitized securities
Conventional asset - backed
securityIslamic asset - linked security
(Theoretical — not current
practice)Security type Fixed income (debt - based) Hybrid depending on the
contract and underlying
assets. Could be quasi fi xed
income or risk sharing or
both
Ownership Security holder does not
own the asset but owns a
security against the asset
Security holder has ownership
interest in the underlying
assetRecourse Security holder does not have
recourse to the asset in the
event of distress
Security holder has recourse to
the underlying asset in the
event of distressPricing
variables
Based on expected yields,
current interest rates, and
other variables infl uencing
the asset owner’s decision -
making to prepay or
refi nance. Creditworthiness
of asset owner or the
guarantor infl uences pricesBased on expected yields,
current levels of returns,
market value of underlying
assets, and expected value
of the underlying asset at
maturityLinkage with
asset value
No direct link to the market
value of the underlying.
Indirect variables such as
loan - to - value (LTV) ratio
are used as proxy.In general, fi nal or other
payoffs may be linked
to market value of the
underlying asset.Principal
protection
Principal is protected
irrespective of the value
of underlying assetsPrincipal is linked to market
value of underlyingRisk shifting Risk transfer Risk sharing