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Intermediate Islamic Finance


Praise for Intermediate Islamic Finance

"This is an excellent book for those who yearn to discover the roots of Islamic finance. Whilst scores of books have been written on the branches and trunk of Islamic finance, this appears to be the first book that neatly links the branches and the trunk to its roots. The book traces the epistemological origins of both conventional and Islamic finance systems and convincingly argues that both systems ought to have grown along risk-sharing models, in line with their original concept of morality and justice as part of an embedded ethical framework in finance. This book is a compulsory read for regulators, policy makers, practitioners, teachers, students, and others who dream of a more equitable and sustainable financial system."
Rafe Haneef, Chief Executive Officer and Executive Director, HSBC Amanah Malaysia Berhad

"This book opens a window on vital chapters in the important research issues related to essential features of Islamic finance. Researchers, as well as students, in particular, who are interested in and confused by the difference between the theory of neoclassical finance and Islamic finance, will be able to find a way to proceed further to the next steps. The authors have presented a superb guide for making progress in the theory of global finance."
Kazuhiko Nishina, former Vice-President and Professor Emeritus, Osaka University

"This book is an excellent intermediate-level treatment of the theory and practice of Islamic finance. Arguments are laid out in lucid and engaging prose, and the analytical approach brings forth clearly the essence of Islamic finance and its relation to conventional finance. This must-read book for students, practitioners, regulators, and researchers also offers a platform for productive debate on the origins of financial crises, the complexity of financial regulation, and the scope of derivatives."
Moosung Kim, former President, Korea Derivatives Association; Professor of Finance, Pusan National University, Korea

"Given that Islamic banking and finance is being taught at many universities worldwide, this book is an important contribution providing new theoretical perspectives on Islamic finance and fills a gap in literature catering to the academic world."
Habib Ahmed, Sharjah Chair in Islamic Law and Finance, Durham University Business School

Nabil Maghrebi is Professor of Finance at Wakayama University, Visiting Professor at Osaka University, and previously Research Fellow at the International Institute for Advanced Studies, Kyoto, Japan. His publications focus on international financial markets and Islamic finance.

Abbas Mirakhor is the First Holder of the Chair of Islamic Finance at the International Centre for Education in Islamic Finance (INCEIF). He is the author of An Introduction to Islamic Finance, Risk Sharing in Finance, and The Stability of Islamic Finance.

Zamir Iqbal is Lead Financial Sector Specialist at the Finance and Markets Global Practice of the World Bank and heads the World Bank Global Islamic Finance Development Center in Istanbul. He is co-author of An Introduction to Islamic Finance, Economic Development and Islamic Finance, and Risk Sharing in Finance.

Preface xi

About the Authors xix

CHAPTER 1 Epistemology of Finance 1

Epistemology of an Ideal Conventional Financial System 3

Epistemology of an Ideal Islamic Financial System 17

Risk-Sharing Finance in a World of Uncertainty 27

Summary and Conclusions 41

CHAPTER 2 Finance and Ethics 47

Renewed Interest in Ethical Finance 48

Embedded Ethical Issues in Financial Theory 50

Cases of Ethical Issues in Finance 51

Virtue Ethics Model 55

Islamic Framework of Business Ethics 58

Summary and Conclusions 69

CHAPTER 3 The Analytics of Finance 71

The Theory of Interest 73

The Concept of Time Value 76

Utility Theory, Risk Aversion, and Risk Premium 87

The Individual’s Optimal Consumption and Portfolio Choices 95

Market Efficiency and the Random-Walk Hypothesis 105

Risk Sharing in Finance 108

Summary and Conclusions 111

CHAPTER 4 Equity, Efficiency, and Firm Behavior 113

Methodological Issues in Islamic Economics 114

Theories of Firm Behavior in Islamic Economics 116

The Profit-Sharing Principle 122

A Theoretical Construct of Equity and Allocative Efficiency 125

Summary and Conclusions 126

CHAPTER 5 Asset Pricing and Corporate Finance 129

Capital Asset Pricing Model 130

Arbitrage Pricing Theory 151

Capital Structure Theory 155

Summary and Conclusions 167

CHAPTER 6 Scope of Financial Engineering and Derivatives 171

Risk Hedging with Forward and Futures Contracts 173

Properties of Options Contracts 188

Option Valuation Theory 200

Applications of Option Pricing Theory in Islamic Finance 210

Risk Hedging and the Scope of Financial Engineering in Islamic Finance 216

Summary and Conclusions 220

CHAPTER 7 Financing Models and Ownership Transfer 223

Structure and Dynamics of Outstanding Balances 225

Ownership Transfer 237

Hybrid Financing Models Based on Risk Sharing 241

Summary and Conclusions 255

CHAPTER 8 Securitization and Structured Finance 257

Risk Transfer with Credit-Default Swaps 258

The Mechanics of Securitization and Structured Finance 264

Complexity of Contract Structures 268

Securitization, Structured Finance, and Completeness of Contracts 273

Securitization, Risk Transfer with Wa’ad Structures, and Options Strategies 276

Summary and Conclusions 288

CHAPTER 9 Financial Stability 291

The Financial System and the Real Economy 292

Financial Crises and Debt Financing 299

Stability of the Islamic Financial System 305

Summary and Conclusions 313

CHAPTER 10 Financial Regulation 315

The Economics of Financial Regulation 316

The Complexity of Financial Regulation 323

The Regulatory Framework under Islamic Finance 329

The Regulatory Challenges in Islamic Finance 336

Summary and Conclusions 340

Appendix A 343

Appendix B 347

References 349

Index 375