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Islamic Capital Markets: Theory and Practice


Everything You Need to Know About One of Today's Most Dynamic, Fastest Growing Global Investment Opportunities

"This is a competent book with an excellent introduction to Islamic capital markets written by an equally competent author. Dr. Krichene's rich background as a macroeconomic analyst of many years has enriched the presentation substantially. The book contains a wealth of information about the workings of conventional and Islamic capital markets that should make it appealing to academicians, practitioners, and students of finance. The analytics are presented in a coherent and easy to understand style. The book would be a worthwhile addition to any finance library."
Abbas Mirakhor, Holder of INCEIF Chair in Islamic Finance

"Dr. Krichene deserves our compliments for making a valuable addition to the literature on Islamic finance which has been gaining momentum around the world over the last few decades. While the careful reading of this book can be highly instructive for everyone, it can be particularly suitable for students because of the simple and convincing style of writing as well as the summary and questions at the end of each chapter."
M. Umer Chapra, Adviser, Islamic Research and Training Institute, Islamic Development Bank

"Dr. Noureddine Krichene's book is a welcome addition to the greatly needed data on capital markets from an Islamic perspective. The author's approach of covering the usual capital market topics along with the theory of money and capital theory puts finance in a broader perspective. This approach offers both the micro level and system-wide implications of the instruments and operations of capital markets. The book provides a systematic treatment of the subject which makes it a good text for students of finance."
Salman Syed Ali, Officer in Charge, Islamic Research & Training Institute, Islamic Development Bank

DR. NOUREDDINE KRICHENE, PHD, earned a doctorate in economics from the University of California, Los Angeles. He has taught Islamic finance at the Global University, INCEIF, in Malaysia, and was an economist with the International Monetary Fund Economist Program from 1986 to 2009. From 2005 to 2007, he was advisor at the Islamic Development Bank of Saudi Arabia. His areas of expertise are the international payments system, macroeconomic policies, finance, and energy and water economics.

Glossary of Arabic Terms

Part One: Islamic Capital Markets: Tools of Securities Investment, Asset Pricing, Risk-Management, and Portfolio Performance

Chapter 1: Capital Theory and Islamic Capital Market
On the Nature of Capital
On the Nature of Interest and Profit
Capital Theory in Islamic Finance
Time Preference and Capital Markets
Capital Productivity: The Inter-Temporal Production Opportunity Set
General Equilibrium: Time-preference and Capital Productivity
Model of Capital as a Subsistence Fund
Capital as Engine of Growth
The Capital Market and The Economy
The Intermediation Role of the Capital Market

Chapter 2: Portfolio Theory and Risk-Return Tradeoff
Market Uncertainty
Portfolio Diversification Theory
The Portfolio Diversification in the Case of Two Risky Assets
A Model of Riskless Asset and a Risky Asset
Asset Pricing Based on Risk-Return Tradeoff
The Security Market Line
Efficiency Frontier, Capital Market Line, Characteristic Line, and the Security Market Line
The Cost of Capital Based on the Capital Asset Pricing Model

Chapter 3: The Analytics of Sukuks
Valuation of an Asset
Valuation of Sukuks
Spot Rates and Forward Rates
The Term Structure of Rates of Return
Sukuk Duration
Sukuk Convexity
Immunization of Sukuk Portfolio
Hedging with Futures Contracts
Understand Risks in Sukuks

Chapter 4: Islamic Stocks
Sharia Screening
Islamic Indexes
Speculation and Gambling
Stock Yield
Common Stock Valuation
Forecasting Stock Prices
Fundamental and Technical Analysis
The Efficiency Hypotheses of Stock Markets
Evaluating Companies
Mechanics of Trading

Chapter 5: The Cost of Capital
Objective of the Firm: Market Value Maximization and the Cost of Capital
Project Selection: the Hurdle Rate
Defining Capital Cost: the Discount Rate
The Net Cash Flow
The Present Value Formula
Relationship Between Risk and the Cost of Capital
Estimating the Cost of Equity Capital and Overall Cost of Capital
Capital Asset Pricing Model (CAPM)
Certainty-Equivalent Versus Risk Adjusted Discount Rates
Applying the CAPM to Calculate Certainty-Equivalent Cash Flow
The Valuation of Securities, Leverage, and the Cost of Capital: Modigliani and Miller Theory
Weighted Average Cost of Capital: 
Implications of the Capital Cost Analysis for the Theory of Investment: Capital Structure and Investment Policy
The Agency Problem

Chapter 6: Asset Pricing Under Uncertainty
Modelling Risk and Return
Market Efficiency and Arbitrage-free Pricing
Basic Principles of Derivatives pricing

Chapter 7: The Consumption-based Pricing Model
Inter-temporal Optimization and Implication to Asset Pricing
Asset Specific Pricing and Correction for Risk
Expected Return-beta Representation
The Mean Variance   Frontier
Risk Neutral Pricing Implied by the General Pricing Formula 
Consumption-based Contingent Discount Factors
The Equity Premium and Interest Rate Puzzles

Chapter 8: Futures Markets
Institutional Aspects of Forward and Futures Contracts
Valuation of Forward and Futures Contracts
Foreign currencies futures and the yield rate parity
Rolling the Hedge Forward
The Hedge Ratio
Cross Hedge
Speculating in Futures Markets

Chapter 9: Stock Index Futures
Specifications of the Stock Index Futures Contract
The Pricing of a Stock Index Futures contract
Hedging with Stock Index Futures
The Minimum Risk Hedge Ratio
Cross Hedge
Target Beta and Capture Alpha with Stock Index Futures
Constructing an indexed portfolio
Asset Allocation
Portfolio Insurance
Index Arbitrage
Program Trading

Chapter 10: Interest Rates Futures Markets and Applications to Sukuks
Types of Interest Rate Futures Contracts
The Pricing of Sukuk Forward Contracts
Hedging with Interest Rate Futures
Interest Rate Futures in Sukuk Portfolio Management
Immunization of Sukuk Portfolio with Interest Rate Futures

Chapter 11: Basic Principles of Options
Options: Basic Definitions
Trading Strategies
Option Pricing
Pricing the Put Option
Call Put Parity
The Binomial Model: Extension to Two Periods
The Option Delta
Risk Neutral Pricing
The Black Scholes (BS) Model
Currency Options
Caps and Floors

Chapter 12: Swaps
Structure and Payoff of a Swap
Motivations for the Swap
The valuation of Plain Vanilla Swaps: the Swap Rate
Currency Swaps
Pricing a Currency Swap
Equity Swap
Credit Default Swap
Total Return Swap
Structured Notes: Inverse Floater and Bear Floater
Options on Interest Rate Swaps: Swaptions
Interest Rate Swaps as Hedging Instruments

Chapter 13: Mutual Funds
What is a Mutual Fund? How Does a Mutual Fund Work?
Index Funds and Hedge Funds
Types of Mutual Funds
Fees and Expenses
Mutual Fund Performance
Mutual fund Advantages and Risks

Chapter 14: Portfolio Performance and Value-at-Risk
Nature and Purpose of the Performance Evaluation
Measuring Performance
Methodologies for Evaluating Performance
The Fama-French Three Factor Model
Performance Attribution Models
Value at Risk (VaR)
Methods for Calculating VaR
Stress Testing and Back Testing

Part Two: Money and Capital Markets

Chapter 15: The Banking System
On the Nature of Central Banking
On the Nature of Money
Fractional Banking and the Money Multiplier
The Central Bank
The Reserves Market: Demand and Supply of Reserves
The Regulatory and Supervisory Role of the Central Bank
The Debate Over the Role of the Central Bank
The Theory of Two Interest Rates
Central Banking and Financial Markets
Central Bank in Islamic Finance

Chapter 16: The Demand for Money
Motives for Holding Money
Demand for Money as Affected by the Rate of Interest
The Baumol-Tobin Model of Money Demand
Equilibrium in the Market for Money
Demand for Money as Influenced by the Price Level
Other Determinants of the Demand for Money
Effects of Changes in the Money Market
The Quantity Theory of Money and Money Demand
The Cambridge Transaction Approach
The Restatement of the Quantity Theory as a Demand for Money Function

Chapter 17: Capital Markets and The Macro-Economy
Financial Crises and Approaches for Recovery
The Income-expenditure Sector
The Monetary Sector
Macroeconomic Equilibrium
Macroeconomic Equilibrium Under Keynesian Assumptions
Classicists’ Approaches to Recovery from Depression
Islamic Approaches to Recovery from Depression
Stagflation and Post-2008 Crisis Unemployment

Part Three: Regulations and Institutions of Capital Markets and Islamic Structured Finance

Chapter 18: Institutions and Regulations of Capital Markets
Regulatory Legislation
The Securities and Exchange Commission
The US Commodity Futures Trading Commission (CFTC)
The Stock Market
Brokerage Firm
Online Trading: A form of Discount Brokerage
Investment Advisers
Central Securities Depository
Investment Banks
Investment Companies
Investment Funds
Mutual Funds
Exchange-traded Fund
Hedge Funds
Money Market Fund
Structured Investment Vehicle

Chapter 19: Institutions and Instruments of Islamic Capital Markets
The Sharia Advisory Council
Islamic Modes of Financing and Islamic Instruments
Islamic Funds
Islamic Derivatives Markets
Guidelines on the Offering of Islamic Securities

Chapter 20: Sukuks
Asset Securitization
Structure and Legal Documentation of Islamic Private Debt Securities
Types of Sukuk Structures
Sukuk Issuance in Practice
Risks Underlying Sukuks Structures
Managing the Financial Risks of Sukuk Structures

Chapter 21: Islamic Structured Products
Structured Finance
Definition of Structured Products
Features of Structures Products
Risks and Benefits of Structured Products
Types of Structured Products
Financial Engineering of Structured Products
Islamic Structured Products
Profit Rate Swap Structure Based on Simplified Parallel Murabaha
Challenges for Islamic Structurers
Examples of Structured Products

About the Author