Islamic Capital Markets: Theory and Practice

Chapter 3

The Analytics of Sukuks

This chapter covers analytical tools of fixed-income securities with applications to sukuks. Sukuks are securitized assets and are discussed further in Chapter 20. This chapter introduces basic methods of valuation of assets with application to sukuks, and defines the notions of yield to maturity, reinvestment of coupons, and par value. It analyzes the important relationship between spot rates and forward rates, bootstrapping techniques for implying forward rates from spot rates, and discusses the applications of forward rates in forward rate agreements (FRAs). The term-structures of rates of return, called the yield curve, is an essential concept of capital markets. The chapter develops theories of yield curves, which include unbiased expectation hypothesis, liquidity premium, market segmentation, and preferred habitat theories. The chapter addresses very important notions of sukuk price volatility, which are the duration and convexity of sukuks. These two concepts play an important role in risk management. The chapter addresses the immunization of a sukuk portfolio, hedging of sukuks with futures contracts against yield risk, and description of main risks associated with investment in sukuks.

The analytical tools of this chapter are highly relevant to sukuks’ capital markets. They provide analysts with models for pricing sukuks, estimating duration and convexity of sukuks, and putting in place hedging and immunization strategies. Moreover, most ...