An Introduction to Islamic Finance: Theory and Practice

128 AN INTRODUCTION TO ISLAMIC FINANCE

the risk through fl uctuations in the security’s price. The investors will be
exposed to the risks of the asset portfolio and will share the losses rather
than being exposed to the creditworthiness of the guarantor. This will put
greater emphasis on the need for prudent selection of underlying assets,
close monitoring of asset performance, and encourage securitization spe-
cialists to structure high-quality securities which offer valuable and secure
investment opportunities.
Given that Islamic capital markets are based on a vibrant stock and
asset - linked securities market, the door is open for the investors to apply
portfolio management techniques to develop optimized portfolios with an
unlimited number of different risk–return profi les. Whereas the stock mar-
ket may have higher volatility, asset - linked securities are expected to exhibit
less variance and thus provide vast diversifi cation benefi ts. The markets
complement each other, have different investor characteristics, and serve as
venues for resource mobilization.
Table 6.2 provides a comparison of a stock market security and an asset -
linked security.

TABLE 6.2 Comparison of stock and asset - linked security

Stock - market security Asset - linked security

Risk Business risk Asset risk
Credit risk

Collateral Business assets (tangible
and intangible)
Equity capital

Underlying assets

Returns Depends on business
growth and earnings;
residual claim on assets

Depends on cash fl ows of

underlying assets

Cash fl ows Less predictable Deterministic

Volatility Medium to high, subject
to sector or business
volatility

Mostly low but could be medium

to high depending on the nature

of securitization and degree of

risk sharing

Contractual
agreement

Equity share

Capital ownership

Diverse, ranging from leases

(rental) to equity (risk - sharing).

Could be amortizing or rental

stream or pass - through

Recourse None. Last claim on
residual assets

Ownership of underlying assets

Pricing Based on the expected
growth and the earnings
of the business

Creditworthiness of asset holder

and the market value of

underlying asset