Islamic contracts and hedge technique Essay Example | Topics and Well Written Essays - 2500 words

Islamic contracts and hedge technique - Essay Example The different aspects of the Islamic hedging techniques have been researched and analysed in this paper. Contents Contents 3 Introduction 4 Discussion 4 Background of Islamic Finance 4 Types of Contracts 6 Hedging Instruments of Islamic Finance 7 Profit Rate Swap 8 Foreign exchange Risk Hedging 9 Conclusion 10 11 References 12 Introduction Islamic Finance has been based on the principles of the Quran or more categorically on the principles of Sharia. According to the principles of Islamic Finance the acceptance and payment of interest is unfair. Thus Islamic Finance is devoid of any payment or receipt of interest in case of any business transaction. This kind of financing technique is adopted for the achievement of the goals which are specific to the Islamic economy. The sharing of the profit and loss is the main principle of the Islamic Sharia. According to the Sharia this measure would bring equity as well as justice in the economy. Hence the alternative names for the banks running on the principles of Islamic Finance are PLS bank. In the financial system there are various types of risks that persist which may result in a huge amount of loss. The hedging techniques are adopted in a financial market in order to cover a particular position of exposure which is generally in relation to a particular financial activity by taking a position that is opposite of what the risky situation is. Most of the banks take such hedging techniques in order to cover the exposures that arise out of the mismatches in the asset and liability of the books of accounts. These kinds of hedging techniques are also prevalent in the context of Islamic Finance. This essay looks into the various risk management measures that are being undertaken in order to provide a solution for the risk exposures and the types of instruments that are being implemented for the purpose. Discussion Background of Islamic Finance The main objectives of Islamic Finance are to promote the principles of Sharia in the ways in which business activities are being conducted. This is done with the objective of promoting growth and prosperity in the economy in a fair way. These financial services would conform to the principles of Sharia and would ensure that the distribution of income in the economy would be equitable and there would be optimal allocation of the resources in the economy in a justified manner. As opposed to the conventional modes of financing which considers interest as the opportunity cost of money, Islamic finance considers the existence of interest as an unjust practice. According to the principles of Islam, loans are provided by one party to the other to meet any kind of contingent situation that may arise. A lender should thus help the borrower to get the loan rather than taking undue advantage of it. Therefore there should be a relation of cooperation between the lender and the borrower. There is no relation of debtor and creditor as in case of commercial banking that is pr actice according to the general convention. The principles of Sharia state that there is simply no return that the people can actually reap unless they take any kind of risk. The principle in is practice in both the capital markets as well as the labour markets. This means that the labourers would not be eligible for wages unless they take some risks while working or bear a cost. On the other hand the capital