An Introduction to Islamic Finance: Theory and Practice

Financial Engineering 265

The importer is able to hedge his/her currency risk and the bank/inves-
tor has earned a 10 percent return, which is also equal to the rate of return
on domestic murabahah, indicating the bank/investor’s opportunity cost.
The above example is a simple demonstration of the construction of
a synthetic currency forward contract. In a capital market where there
are large numbers of users and providers of capital, a fi nancial interme-
diary can serve the purpose of matching the needs of both entrepreneurs
and investors. The fi nancial intermediary that has wider access to several
money and capital markets can perform the function more effi ciently by
standardizing the products, enhancing credit through underwriting (kifala)
and offering clients risk management services for a reasonable fee (in the
form of jo’alah).
Figure AC1 illustrates the construction of the synthetic forward con-
tract in our example.

AT TIME OF CONTRACT (T 0 ):

AT TIME OF DELIVERY (AFTER THREE MONTHS):

INVESTOR/

DEPOSITOR

FINANCIAL

Receives Investment of INTERMEDIARY

€ 809,524

Foreign

Capital

Market

Converts € 809,524 at Spot rate of €

0.85/$ into $952,381 and invests in a

murabahah contract at R$

IMPORTER

Quotes forward rate

of € 0.8905/$ under a

jo’alah contract

INVESTOR INTERMEDIARYFINANCIAL

Returns € 890,500 to

the investor.

Investor's return = Rrs

Foreign

Capital

Market

Receives $100,000 against

murabahah contract.

IMPORTER

Delivers $1000,000

against jo’alah contract.

Receives €809,500.00

under jo’alah contract

FIGURE AC1 Construction of a synthetic forward contract
Note: Illustration does not take into account any transaction cost or fi nancial inter-
mediary’s fees.