Sukuk Securities: New Ways of Debt Contracting

CHAPTER 13 Cash-Flow Identification and Pattern Recognition for Theoretical Valuation Models

In this study, a couple of assumptions have been made to simplify the calculations or generalize the findings. These assumptions may affect the applicability of the findings, to some extent, but they are necessary at this stage. We try to keep assumptions to a minimum, however.

The first assumption made in this study is that the interest (more correctly for sukuk the discount) rate is fixed for the whole tenure of a security. This assumption contradicts reality, but it is used in the examples because it simplifies the mathematical processes.

The second assumption is that the risk characteristics (i.e., risk rating) of a particular sukuk security is stable for the whole tenure of the security. The most common sukuk has a five-year tenure, during which time the nature of the firm may change; hence, the rating may not be stable. Again, this might not be the case in reality, but it has been assumed to make the mathematical calculation simpler. There are cases in which a security’s rating has been upgraded or downgraded at a specific but unknown point in time before maturity. Changes in the risk characteristics and rating of a particular security will directly influence the investors’ expected yield and, subsequently, the discount rates applied.

ZERO-PROMISED REGULAR-PAYMENT SUKUK

The theoretical valuation of sukuk can be achieved by following the same approach and rationale used for ...