An Introduction to Islamic Finance: Theory and Practice

264 AN INTRODUCTION TO ISLAMIC FINANCE

The following illustrates the calculations involved in a synthetic forward
contract and the profi t made by the bank or the investor in our example:

Local currency: Euro (€)

Foreign Currency: US Dollar ($)

Period: 3 months

Rate of Return on 3 - month murabahah in domestic

market (R€): 10%

Rate of Return on 3 - month murabahah in foreign

market (R$): 5%

Spot Rate: €0.85/$

Amount to hedge: €1,000,000.00

Amount of investment required in foreign currency at settlement
date (T 0 ):

Amount of investment required in local currency at settlement date (T 0 ):

Foreign Amount × Spot Rate  $952,381 × 0.85  €809,524

Convert €809,524 @ €0.85/$ to $952,381 and invest the proceeds in $
murabahah with expected rate of return = 5 percent.
Arbitrage - free forward rate (F) quoted to importer:

Value of murabahah at maturity (T):

Investment amount × (1Rate of Return)  $952,381 × (1.05)  $1,000,000

The bank received $1,000,000 from foreign murabahah investment and
sold $1,000,000 to the importer at €0.8905/$ and received €890,500.00.
The bank or investor’s rate of return: