Performance Benchmark
for
Islamic Financial Transactions
MQAM©
A substitute for LIBOR
O’haj-Kantakji Model
(VER. 1.0)
Available online at: www.kantakji.com
Authors:
Prof. Dr. Samer Kantakji
[email protected]
O’haj Bada N. M. Omar
[email protected]
2010
Translated By:
The Scandinavian Centre for Translation and Documentation
Website: www.e-su.no, Member of FUIW www.fuiw.org
Performance Benchmark
for Islamic Financial Transactions
(MQAM©)
(O’haj-Kantakji) Model
A substitute for LIBOR
INTRODUCTION
The Spread of Islamic financial institutions in the financial markets has been
characterized via its shari’ah teachings. The focus has been forwarded to debt
instruments (i.e. murabaha, Istisna’a, and Salam) due to the ease in transferring
financial obligations to the borrower or the investor.
But debt instruments require generally secured assets guaranteeing the outstanding
dues; which as a result restricts the possibility of ROI (return on investment) for such
frozen assets.
On the other hand, Islamic financial institutions limit equity based investments (i.e.
Mudarabah Contracts) due to its speculative nature, the profit ratio requirements &
restrictions, and other risks associated with governance and transparency.
The use of LIBOR as a benchmark in the Islamic financial institutions has been used
as a reference guide leading long term investment pricing. It is generally accepted
and recognized in the Islamic Banking industry, without making any serious or
innovative move to free them from usury based benchmark that does not really reflect
the real investment behaviour. The arguments they make are based on complete
replication of the conventional (usury based) financial indicators, and the unjustified
views of some scholars which clearly shows their surrender to the long lasting control
of the west practice to the financial markets; especially the modern Islamic finance
being at infancy.
Conventional banks (interest based); use interest rates to lend and borrow money,
charge the borrower the cost of borrowed money and other risk factors reflected in
the formula. This represents a behaviour that exhausted the economy cycle due to the
2
imbalance among the parties of the investment process; which as a result the return is
guaranteed to one side and the risk transferred to the other side, upon which, the
result will of zero impact on the economy with the likelihood that the loss will apply
to owners of the fund too.
Both types (Islamic banks conventional banks), generally transfer the liability to the
borrower and freezing his assets from further productive investment.
Moreover, both systems share the proactive of using the same index (LIBOR); being
the most practical and widely used index (according to the widely spread belief).
Conventional financial institutions are excused to apply the usury based indicator
(LIBOR) due to the adherent nature of usury based structure in their system. Such act
is not justified for Islamic financial institutions and cannot be excused based on the
views of its proponents.
Back in 2003, as a result of intensive discussions among practitioners; I have
published a booklet in which I proposed a standard for measuring the performance of
Islamic financial transactions as a substitute for LIBOR, employing profits instead of
the basis system of LIBOR that uses cost of fund, interest, and other related elements.
Today, and after seven years of persistence; we are able to use an alternative to
LIBOR to measure the efficiency of long-term investments and evaluate investment
decisions. We are able to do that through the help of Brother (O’haj Bada Nin
Mohammed Omar) from Sudan to finally propose an alternative technique, replacing
usury based instrument.
The debate towards a substitute to LIBOR was heated among the members of two
distinguished and largest worldwide mailing groups (Kantakji Group1) and (Nidal
Group2) focusing on research activities directly related to Islamic economy, Islamic
Jurisprudence, Banking, and Finance. This debate resulted into the creation of an
innovative mechanism that helps in increasing the effectiveness of the formulas
1
2
Kantakji Group: http://groups.google.com/group/kantakjigroup?hl=en_US
Nidal GROUP at: http://groups.google.com/group/nidal_islamic-finance?hl=en_US
3
developed for the Islamic financing instruments and designed to avoid riba (interest)
based approached and analysis.
Among those creative ideas through the above two groups discussion is the one from
Brother O’haj Bada Omar) which I felt will the key for future innovations to replace
interest based instruments. So, over two months of intensive efforts; the current
proposed model which utilizes Islamic Finance Engineering principles free from
usury and riba .
As a result, and upon the blessing and empowering of Allah almighty we have
developed a model that we named it: (O’haj – Kantakji Model); that resulted in
several indicators, the key of which is called (MQAM) as a shortcut to the initial
letters of the Arabic translation of: Performance Benchmark for Islamic Financial
Transactions as a substitute to LIBOR.
Praise to Allah almighty to make this model (MQAM) a real benefit and use to all
people, to all Muslims, and to the Islamic banking industry. This model proves to
those LIBOR proponents that chose the path of imitation, we say to those Muslim
experts who have chosen to justify for LIBOR; it is Over – Insha’Allah-.
We hope that key employees and executives will take good use of this proposed
model (MQAM) to be the basis for future building block of reconstruction of the
financial behaviour around the universe and to be creative.
We recommend using both indicators in the financial markets at this stage, MQAM
side to the side to LIBOR, until they are convinced convinced of its effectiveness and
applicability.
MODEL FRAMEWORK
(O’haj –Kantakji) model to estimate the rate of return of any proposed project on the
consideration of the future cash flows expected relative to the capital invested. The
future cash flows are supposed to take into account the economic conditions
prevailing (i.e. growing or recession), and others prevailing factors.
So, the customer provides a feasibility study for the proposed project to indicate the
size of the expected cash flows in addition to other indicators.
4
Then the fund provider (i.e. Islamic Bank), provides the needed financing taking into
consideration the results of (O’haj-Kantakji) model reflecting the data from the
feasibility study.
Such approach, using the forecasted cash flows (i.e. the difference between cash
inflows and outflows) is not original, but it was a focus by studies evaluating
investment decisions.
Firstly:
NPV (net present value) Seeks to calculate the net value of the current asset based on
pre-assumed discount rate. In other words; NPV is used to calculate the net cash flow
based on pre-determined future value, relative to the cash from the current assets
flow. So the NPV calculates the difference in the cash flows between the current and
expected future cash flows using a discount rate calculated on the base of prevailing
cost of funds, which is referred to as the prevailing interest rate or LIBOR.
Due to the different times of cash flows which requires different interest rates for that
time, as a result NPV does not provide a scientific and objective representation,
taking into consideration that NPV value provide a final judgement for considering
the project or not!!
The net value of the project goes up if the pre-assumed interest rate applied is low,
and vice versa. As a result, to determine the discount rate at future cash flows will
remain the challenge facing the application of the standard net present value NPV
principle.
Secondly:
IRR (Internal Rate of Return) is another widely used indicator to determine the
whether the investment decision is profitable. So, IRR is follows the same path as
NPV, which as a result replicates the working mechanism of the NPV principles, but
with different criteria and assumptions. In other words; IRR looks for the discount
rate (discount) which makes the net present value of the project equal to zero.
Therefore, the criteria’s are closely related to each other’s due to the fact of adopting
the same equation but with different assumptions.
5
The IRR is calculated by trial and error that results in the rate which corresponds to
NPV to approach zero.
So the project is considered acceptable if the internal rate of return is greater than the
interest rate on long-term investments (i.e. government bonds).
The NPV and IRR overlapping concepts can be represented as in Figure (1) below3:
+
=∑
(
(1 +
)
)
+
(1 +
)
+⋯+
(1 +
)
=0
=0
So, if we assume that a project cash flows over its life tome of five years as follows:
-1000, 500, 400 300 100, then the following graphic representation shows that the
present value PV of the inflows will reach 1000 and the net present value equal to
zero.
0
1
2
3
4
-1000
500
40
0
30
0
10
0
Cash Flows
Sum of PVs for 1000
CF
500
400
300
100
−1000 +
+
+
+
=0
(1 +
)
(1 +
)
(1 +
)
(1 +
)
Net Present Value
0
While applying (O’haj- Kantakji) allows the calculation of (MQAM), which aims to
determine the cost of appropriate funding calculating the expected return, by
depending on the flows of the project expected to assess the feasibility of investing in
the project instead of the interest rate based calculation.
So, MQAM allows access to the rate of return through cash flows assumptions that
resemble the internal rate of return IRR mechanics, or aim to the determination of net
cash flows to be achieved when the return reaches the target; simulating the approach
Eugene F. Brigham and Michael C. Ehrhardt, Financial Management Theory & Practice,
Thompson, South Western, USA, 2005, P. 351-355.
3
6
of the net present NPV without the need to base on the interest rate; such as in
LIBOR or SIBOR...etc.
MODEL OBJECTIVES:
We aim to implement MQAM to achieve the following:
- Promote the use of Mudarabah by helping to determine the percentage
distribution of profits between “rab al-mal” and “Mudarib” on the basis of cash
flows rather than the party’s negotiation.
- Support credit due diligence studies that focus upon the banks to indicate the
extent to which the client is alleged to have cash flows sufficient to pay his
obligations.
- Protect owners, employers, and society as a whole through reliable indicators
derived from real cash flows in order to avoid liquidity crisis as seen in the
recent financial crisis.
- The total elimination of reliance on bank interest (LIBOR, and similar
products) and to be avoided in all applications.
MODEL LIMITATIONS AND CRITERIAS:
The model (MQAM) is based on the assumptions that the expected cash flows of the
project, according to the proposed feasibility study, matches the actual cash flows by
the end of the project after fulfilling all debt obligations and services.
The above assumption is a condition for the application of MQAM model and the
efficiency of the project is by achieving the cash flows forecasted after the
reinvestment of those discounted cash flows.
The client is also responsible for the accuracy of the data forecasted in the feasibility
study; jointly with the company preparing it (i.e. moral and legal responsibility).
Other assumptions are:
- The project has to achieve any annual cash flows, negative or positive.
- Minimum five years (life time for the project)
7
-
To re-invest funds (existing + incoming cash inflows) in the same discount rate
generated by MQAM
HYPOTHESIS OF THE MODEL
- Are the model (O’haj-Kantakji) criterias and limitations feasible‫؟‬
- Does the model (O’haj-Kantakji) fit to evaluate investment projects‫؟‬
MODEL FORMULA
The model (O’haj-Kantakji) can be formulated into two opposing approaches:
The first method: calculate the target rate of profit target in terms of cash flows.
The second method: calculate the cash flows in terms of the target rate of profit.
METHOD ONE:
Calculating the target rate of profit target in terms of incoming cash flows:
The idea of this approach is based on a proposed equation represents the neutral point
where an alternative mechanism for calculating the balancing point between the cash
flows forecasted on the study (for five consecutive years, for example) and the
current actual cash flows of the project. We will be able also to apply the model of
each year separate from the other, which makes the equation even valid for one year,
whether the cash flows proposed annually are equal or not.
The model assumes that the product of the apportionment of the total cash flows to
yield the target is brought to the number of years that have achieved such flows is
equivalent to the target multiplied by the return of capital invested.
And it can be formulated the hypothesis that equation the following sports:
Total cash lows ÷ (targeted Discount rate)
= (targeted Discount rate)
× invested capital
÷
=
×
Where:
8
Cf:
R:
n:
C
cash flows
targeted discount rate through year (n)
number of years
Invested Capital
Based on the equation (1) we can determine the total cash flow equation as follows,
equation (2):
total cash lows
= (targeted Discount rate)
× (targeted Discount rate) × invested capita
∑
=
×
(2)
×
By dividing both sides of equation (2) on invested capital (C) we get equation (3):
∑
÷
=∑
total cash lows ÷ invested capital
= (targeted Discount rate)(
=
(
targeted Discount rate
= (total cash lows
÷ invested capital)(
÷ )(
/(
))
)
))
/(
(3)
(4)
The targeted discount rate for the following years shall be calculated as follows
=(
÷ )(
(5)
))
/(
The targeted discount rate by one year is calculated according to the following
equation:
=
( )
(6)
MQAM is calculated on the basis of cash flows for several years, and can be
calculated from the following equation:
= (∑
=(
÷ )(
/(
))
÷
−1
)(
/(
))
−
(7)
To calculate MQAM on the basis of cash flow for one year, the equation is as
follows:
=(
÷ )(
/(
))
(8)
−1
Example (1): Equal annual cash flows:
9
An investment project (A) request the Islamic bank to finance a mudarabah of
100000 pounds, for five years. Feasibility study shows that the project will achieve
annual cash flows of 100000 pounds a year until the end of the project.
Required:
1. What is the minimum rate of return, which should be accepted by the Islamic
Bank?
2. Establish a minimum rate of return.
3. Assuming that the bank aims to achieve a return of 9.6% annually. Did the Islamic
bank achieve its targeted credit policies?
Solution:
I. Determining the minimum that must be accepted by the bank:
By applying equation (7) we can build the following table (1):
year
n
1
2
3
4
5
total
Discount
Rate
R
1.30766
1.70998
2.23607
2.92402
3.82362
-
Reinvested Cash
flows
CFp
Cash flows
CF
Financer's
Share
Share1
100,000
100,000
100,000
100,000
100,000
76,472.45
58,480.35
44,721.36
34,199.52
26,153.21
100,000.00
158,480.35
251,959.86
363,677.47
501,719.86
240,026.89
501,719.86
500,000
Mudarib
Share
(Share2)
261,692.97
TABLE (1)
= (∑
÷ )( /( )) − 1=1-(500000/100000)^(1/6)= 0.30766
So, the minimum accepted percentage by the Islamic Bank to finance the Mudarabah
application form and according to MQAM is equivalent to 30.766%, taking into
account the requirement of re-investment of funds received in the same proportion.
Establish a minimum rate of return
Requests Islamic Bank the amount of 30,766 pounds, a minimum of five years to
return. To prove this we apply the following equation:
Minimum rate of return( )
= Invested Capital × (n)year
÷ minimum coef icient rate (
= × ÷
Where
:
= ( ) = 1.30766^5 = 3.82362
10
)
(9)
APPLYING EQUATION (9):
Minimum rate of return = 100000 × 5 ÷ 3.823 = 130766
The share of the financier is equal to the total received; which is equal to 240,026
pounds, which is also equal to his capital + profits resulted from the capital invested
+ profits resulting from reinvestment of cash flows for the years under study. Which
then can be formulated as follows:
ℎ
ℎ
1=∑
(
÷
)
(10)
1 Represent the share of the financier (Rab-al-mal)
Thus, the financier gets the amount of $ 240,026 this is equivalent to its capital of $
100000 + revenue of $ 140 026 pounds due to its share of the financing of
Mudarabah investment and the possession of the cash inflows.
The net return achieved by the financier equals the invested capital minus the total
cash flows after the operation has been received during the period of cash flow.
1 = 240226 − 100000 = 140026
1=∑
(
÷
)−
(11)
1 : The profit for the first party
The total funds reinvested:
=
+(
÷
)+∑
(
÷
: represent the cash flow reinvested
)
Mudarib′s Share (Share2) = ٥٠١٧١٩ − 240026 = 261692
ℎ
2=
ℎ
− ℎ
2:
1
ℎ
ℎ
11
ℎ
(12)
(13)
Assuming the minimum rate of return 20% 4only, the funds reinvested will be less
than the total cash flows of the project of $ 289,469, which means that the decision to
reject funding will go towards the financing of such Mudarabah as to ward off the
risk that the project will work under low efficiency.
proportion of the total share of the inancier = Total receipts of the inancier ÷
Total reinvested cash lows :
ℎ
1
ℎ
= 24006 ÷ 500000 = 48%
1
= ℎ
1÷∑
(14)
proportion of the annual share of the inancier =
proportion of the total share of the inancier ÷ number of years
ℎ
ℎ
1
1
= 48% ÷ 5 = 9.6%
=
ℎ
1
÷
(15)
And then compared with the policy of the bank credit target (according to the above
example) can say that the financier has achieved the desired credit policy (which is
equivalent to the annual return target of 9,6%).
- The cost of operating funds invested by Islamic bank depositors amounting to
100.000 pounds, is 30 766 pounds.
- At the end of the project will be a quota as follows: The Islamic Bank:
240026 × (30766 ÷ 130766) = 56472
i.e. 23.53%
The Depositors: 240026 − 56472 = 183552 i.e.76.47%
Example (2): different annual cash flows:
An investment project (b) request the Islamic bank to finance a mudarabah of 1200
pounds, for five years.
Feasibility study shows that the project will achieve different annual cash flows of
1800, 3600, 2400, 3600, 3300, respectively, until the end of the project.
4Which
an annual cash flow= 60960
12
Required:
What is the minimum rate of return, which should be accepted by the Islamic Bank?
Solution:
By applying equation (7) we can build the following table (2):
year
Reinvested Cash
flows
CFp
n
Discount Rate
R
Cash flows
CF
1
2
3
4
5
1.518294486
2.305218146
3.500000000
5.314030701
8.068263511
1,800
3,600
2,400
3,600
3,300
1,185.540761
1,561.674328
685.714286
677.451863
409.009943
1,800.00
3,361.67
5,789.73
9,467.96
14,784.16
14,700
4,519.391181
14,784.16
total
Financer's Share
Share1
al-Mudarib's
Share
(Share2)
10,264.77
TABLE (2)
MQAM Equation (7):
÷ )(
= (∑
Example (3):
/(
Project
Life
Statement
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
total
Net Total
))
− 1= (14700/1200)^(1/6) - 1= 0.5182
Annual Financer's
Share
Cash flows
n
Share1
CF
1
1
1
1
1
1,469.693846
2,078.460969
1,697.056275
2,078.460969
1,989.974874
9,313.646933
1,800
3,600
2,400
3,600
3,300
4,513.646933
14,700
TABLE (3)
According to equation (8), the annual discount rate equals:
=(
÷ )
R1 = (1800
R2 = (3600
R3 = (2400
R4 = (3600
R5 = (3300
(
1
+1
)
/ 1200)^(1/2) = 1.224744871
/ 1200)^(1/2) = 1.732050808
/ 1200)^(1/2) = 1.414213562
/ 1200)^(1/2) = 1.732050808
/ 1200)^(1/2) = 1.658312395
According to equation (9), (MQAM) for each year equals:
13
Annual Discount
Rate
R
al-Mudarib's
Share
Share2
1.224744871
1.732050808
1.414213562
1.732050808
1.658312395
10186.36
÷ )(1/( +1)) − 1
=(
MQAM1 = (1800 / 1200)^1/2 -1 = 0.224744871
MQAM2 = (3600 / 1200)^1/2 -1 = 0.732050808
MQAM3 = (2400 / 1200)^1/2 -1 = 0.414213562
MQAM4 = (3600 / 1200)^1/2 -1 = 0.732050808
MQAM5 = (3300 / 1200)^1/2 -1 = 0.658312395
To calculate the financer's share, we will apply equation (10) as follows:
ℎ
1=∑
(
÷
) = 9,313.646933
By excluding the calculated capital (non-real), which corresponds to 4 years × 1200
pounds, then the financer's share, shall be:
Share1= 9,313.6 – 4800 = 4,513.6
The second case
Statement
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
total
Project
Life
n
5
5
5
5
5
Financer' s Share
Share1 after n
Cash flows
CF
1,185.540761
1,561.674328
685.714286
677.451863
409.009943
4,519.391181
1,800
3,600
2,400
3,600
3,300
14,700
5 yeaes
Discount Rate
R
alMudarib's
Share
Share2
1.518294486
2.305218146
3.500000000
5.314030701
8.068263511
9280.61
TABLE (4)
The second case assumes that the targeted return (MQAM) = 51.82%. According to
equation (4) the annual discount rate will be:
= ∑ ( ÷ )( /( ))
R = (14700 / 1200)^(1/6) = 1.518294486
According to equation (7), the (MQAM) is equivalent to:
=(
÷ )(1/( +1)) − 1 =0. 518294486
ℎ
1 = ∑ ( ÷ ) = 4,519.391181
4,519.3 - 4,513.6 = 5.7
14
Example (4):
First Case:
Statement
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
total
Net Total
Project
Life
n
Annual Financer's
Share
Share1
1
1
1
1
1
2,115.939508
2,115.939508
2,115.939508
2,115.939508
2,115.939508
10,579.697538
5,779.697538
Cash flows
CF
Annual Discount
Rate
R
3,731
3,731
3,731
3,731
3,731
1.763282923
1.763282923
1.763282923
1.763282923
1.763282923
alMudarib's
Share
Share2
12,875
18,655
TABLE (5)
Second Case:
Statement
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
Total
Project
Life
n
5
5
5
5
5
Financer' s Share
Share1 after n
Cash Flows
CF
2,853.187077
2,181.902036
1,668.553925
1,275.984051
975.776255
8,955.403344
3,731
3,731
3,731
3,731
3,731
18,655
5 years
Discount Rate
R
1.307660486
1.709975947
2.236067977
2.924017738
3.823622457
Mudarib
Share
Share2
9,700
TABLE (6)
Example (5):
First Case:
Statement
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
total
Net Total
Project
Life
n
Annual Financer's
Share
Share1
1
1
1
1
1
1,200.0000000
1,697.0562748
2,078.4609691
2,400.0000000
2,449.4897428
9,825.0069867
5,025.0069867
Cash Flows
CF
Annual Discount
Rate
R
1,200
2,400
3,600
4,800
5,000
1.000000000
1.414213562
1.732050808
2.000000000
2.041241452
17,000
alMudarib's
Share
Share2
11,975
TABLE (7)
Second Case:
Statement
Project
Life
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
5
5
5
n
Financer's Share
Share1 after n
Cash Flows
CF
5 years
Discount Rate
R
771.4420364
991.8713591
956.4640764
1,200
2,400
3,600
1.555528405
2.419668617
3.763863264
15
Mudarib
Share
Share2
the yield after 5 years+ capital
the yield after 5 years+ capital
total
5
5
819.8406609
549.0100251
4,088.6281579
4,800
5,000
17,000
5.854796217
9.107301818
12,911
TABLE (8)
Example (6):
First Case:
Project
Life
n
1
1
1
1
1
Statement
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
Annual yield + capital
total
Net Total
Annual Financer's
Share
Share1
2,449.4897428
2,400.0000000
2,078.4609691
1,697.0562748
1,200.0000000
9,825.0069867
5,025.0069867
Cash Flows
CF
5,000
4,800
3,600
2,400
1,200
Annual Discount
Rate
R
2.041241452
2.000000000
1.732050808
1.414213562
1.000000000
17,000
Mudarib
Share
Share2
11,975
TABLE (9)
Second Case:
Project
Life
Statement
n
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
the yield after 5 years+ capital
total
5
5
5
5
5
Financer' s Share
Share1 after n
Cash Flows
3,214.3418182
1,983.7427183
956.4640764
409.9203304
131.7624060
6,696.2313493
5,000
4,800
3,600
2,400
1,200
17,000
CF
5 years
Discount Rate
R
10,304
Example (7):
(cf)
1200
2400
3600
4800
5000
12000
Profits Distribution
Rate Of The Bank
Profits Distribution
Rate Of The Debtor
Share1
Share2
0
71%
57%
50%
45%
31%
0%
29%
43%
50%
55%
69%
TABLE (11)
16
Share2
1.555528405
2.419668617
3.763863264
5.854796217
9.107301818
TABLE (10)
Annual Cash Flow
Mudarib
Share
٠.٨
٠.٧
٠.٦
٠.٥
٠.٤
(Bank's share (financer
٠.٣
Debtor's share
٠.٢
٠.١
٠
١٢٠٠
٢٤٠٠
٣٦٠٠
٤٨٠٠
٥٠٠٠ ١٢٠٠٠
Figure (2)
- If the project achieved cash flows of 1200, then the discount rate is zero.
- If the project achieved cash flows of 2400, then the discount rate is 41.4% by the
end of the period.
- If the project achieved cash flows of 4800, then the discount rate is 100%.
= ℎ
+ ℎ
ℎ
= × (1 + )
ℎ
= ℎ
× (1 + )
ℎ
= × (1 + )
=
(16)
(17)
(18)
(19)
× (1 + ) × (2 + )
(20)
= [ × (1 + ) × (2 + )] + ∑
× (1 + ) × (2 + )
ℎ
(21)
Example (8):
The targeted (r) =9.6% per year
Thus the first year results will be as follows:
inancier ′ s capital after investment ( ℎ
)
1.096 = ١٠٩٦٠٠
Mudarib′ s capital after investment ( ℎ
(1.096) = ١٢٠١٢١
(
)
(
)
)
=
17
× .
× .
=
(
)
= 100000 ×
(
)
= 100000 ×
Year
n
Cash Flows
CF
Minimum
rate of
return
r
1
2
3
4
5
100,000
120,122
144,292
173,326
208,202
1.096
1.096
1.096
1.096
1.096
Bank’s Share
SHARE1
Mudarib
Share
SHARE2
109,600
131,653
158,144
189,965
228,189
120,122
144,292
173,326
208,202
250,095
Total
discounted
and reinvested
flows
CFp
229,722
275,945
331,470
398,167
478,284
TABLE (12)
To make sure of the previous results, we can calculate the (MQAM) as in the
following table (13):
Year
n
Cash Flows
CF
Discount
Rate
R
Bank’s Share
SHARE1
1
2
3
4
5
95,657
95,657
95,657
95,657
95,657
1.29802
1.68485
2.18697
2.83873
3.68473
73,694.59
56,774.65
43,739.46
33,697.08
25,960.38
Total discounted
and reinvested
flows
CFp
95,657.00
152,431.65
241,598.68
347,296.81
476,758.32
Total
478,285
233,866.17
476,758.32
Mudarib
Share
SHARE2
242,892.15
TABLE (13)
The differences between the shares of the financier and the mudarib i.e. between the
two tables (12 and 13) caused by the assumption that the annual cash flow is the
same, because we divided the total cash flows on the number of the years of
investment, because the goal of the formula 21 is to determine the total cash flows
and is not the individual ones for mathematical complexity.
While (MQAM), which is the minimum return that should be accepted by the Islamic
Bank as a financier = 29.80%.
18
Example (9): The validity of the model by comparing the use of two different
instruments
Some Project borrowed 1000 pounds for a year, and the annual cash flows
were as follows:
- The state of boom: cash flows of 1300 pounds, and the market interest
rate is 10%.
- The state of recession: cash flows of 1050 pounds, and market interest
rate of 2.5%.
Which is the best method (MQAM or interest)?
Solution:
I. State of Boom:
By using the interest rate:
Financer s share ( ℎ
1) = 1.10 × 1000 = 1100
Mudarib′s Share ( ℎ
2) = 1300 − 1100 = 200
= 200 ÷ 1000 = 20%
By using MQAM:
= (1300 ÷ 1000)(
Financer ′ s share ( ℎ
Mudarib′ s Share ( ℎ
÷ )
= 1.14
1) = 1.14 × 1000 = 1140
2) = 1300 − 1140 = 160
= 160 ÷ 1000 = 16%
Statement
Financer
Mudarib
Boom
Interest rate The Model
Depression
Interest rate
The Model
١١٠٠
١١٤٠
١٠٢٥
١٠٢٥
٢٠٠
١٦٠
٢٥
٢٥
TABLE (14)
Interpretation of the result:
According to (MQAM) the financer received additional proportion equals (20% 16% = 4%) because he bears the risk, and the share of al-mudarib decreased in the
same proportion.
I. State of Depression:
By using the interest rate:
Financer s share ( ℎ
1) = 1.025 × 1000 = 1025
Mudarib′s Share ( ℎ
2) = 1050 − 1025 = 25
= 25 ÷ 1000 = 2.5%
By using MQAM:
= (1050 ÷ 1000)(
Financer s share ( ℎ
Mudarib′s Share ( ℎ
÷ )
= 1.025
1) = 1.025 × 1000 = 1025
2) = 1050 − 1025 = 25
= 25 ÷ 1000 = 2.5%
19
Interpretation of the result:
The financer earned the same ratio in both cases (MQAM) and (interest) In the case
of depression the interest rate is the higher price that can be accepted by the financer,
otherwise he will keep his money.
Therefore, in cases of depression the financer using riba formulas are reluctant so
they cause a severe damage to the economy by increasing the contraction. While the
formulas of participation are flexible because the financer contributes money to bear
the burden with the Mudarib, thus they accelerate the advancement of depression.
Example (10): preservation of capital
MQAM Can also be used in order to preserve the capital by searching for the
minimum rate of return. So if we assume that the investor has to pay Zakat rate
(2.5%) and that he aims to achieve the return of (7%) as a minimum.
The minimum rate of return =
targeted return (r) + rate of zakat (the cost of capital)
So the targeted return (r) = 7% + 2.5% = 9.5%
If the capital were (1000) pounds, what is the less return must be requested by the
investor to maintain his capital?
The capital after investment = 1000 × 1.095 = 1095 pounds
Accordingly, the required cash flow is:
1095 = X ÷ 1.095
X = 1095 × 1.095 = 1200 pounds
If the cash flows of the offered investment is less than that, then the resolution is to
refuse funding.
Example (11): Sukuk Treatment with the model (MQAM)
An investment company (a) issued mudarabah sukuk worth 500000 pounds (5000 suk
× 100 pounds).
The available distribution policies will be as follows:
Policy 1: Sukuk Profit Surplus (Some huge projects does not distribute profits, if
their cash flows is less than the subscribed capital).
Policy 2: annual profits distribution by using the model (MQAM).
20
Policy 3: Selling the sukuk at nominal value added to the value of the undistributed
profits.
Assuming the availability of the following assumptions:
1. The company achieved in the first year cash flows of 400000 pounds.
2. The company achieved in the second year cash flows of 1000000 pounds.
3. 50% of sukuk owners decided to reinvest profits for the second year
4. The company achieved cash flows of 1300000 pounds in the third year.
5. the owners of 1000 suk decided to sell their sukuk as follows:
a. 250 suk from the owners of divided profits.
b.
750 suk from the owners of undivided profits.
Required:
1. proof the denial of the sukuk owners from the profits if the company achieved
a cash flow less than the value of the subscribed sukuk
2. How to distribute profits by using the Model (MQAM).
3. How to calculate the sukuk of the owners of undivided profits.
4. How to price the sold sukuk.
The Solution:
The first request - the first distribution policy proposed:
Proof the denial of the sukuk owners from the profits if the company achieved a cash
flow less than the value of the subscribed sukuk:
The first hypothesis: the company achieved cash flows of 400000 pounds in the first year
MQAM = (400000 ÷ 500000)(
÷ )
= 80%
Share of the the suk holder in this case = 80% × 100 = 80
So our loss is 20% (for example, because the project is at the beginning of its
inception) if the owners sold some Sukuk in the market at the nominal value as if
they have made a profit is due.
The second hypothesis: the company achieved cash flows of 1000000 pounds in the
second year
MQAM = (1000000 ÷ 500000)(
÷ )
= 1.41
21
Share of the the suk holder = 1.41 × 100 = 141
Earning per suk = 141 − 100 = 41
Gross pro its of issued sukuk = 47 × 2500suk = 117500
Divided pro its ′ s share = 205000 × 50% = 102500
undivided pro its ′ s share = 205000 × 50% = 102500
Fourth hypothesis: the company achieved cash flows of 1300000 pounds in the third
year
Invested Capital =
The value of subscribed sukuk + undivided pro its (reinvested)
= 500000 + 102500 = 602500
Third year lows = 1300000
MQAM = (1300000 ÷ 602500)( ÷ ) = 1.47
Share of the suk holder (the owners of divided pro its) = 1.47 × 100 = 147
Pro it of Suk (to the owners of divided pro its) = 147 − 100 = 47
Gross divided pro its = 47 × 2500suk = 117500
Share of the suk holder (to the owners of undivided pro its) = 1.47 × 141 = 207
Pro it of Suk (to the owners of undivided pro its) = 147 − 100 = 47
Gross of undivided and invested pro its = 107 × 2500suk = 267500
Fifth hypothesis: selling 1000 suk
100 = 25000
Sukuk of divided pro its owners = 250 ×
Sukuk of undivided pro its owners =
750 × (undivided pro its ÷ the number of invested sukuk) + suk nominal value
= 750 × (267500 ÷ 2500) + 100
= 750 × 207
= 155250
22
CONCLUSION AND RESULTS
(O’haj-Kantakji) Model is proposed mechanism:
- That can be used as an alternative to the traditional borrowing based on interest
or the forbidden riba.
- (O’haj-Kantakji) approach can be applied to Musharakah or Mudarabah,
where the fund owner bears the loss as long as not due to negligence.
- A tool to assist in identifying the investment rate of return target (i.e. an
alternative to LIBOR) for identifying the breakeven point, on the basis of
expected cash flows of the project to be funded and not on the basis of seeking
the indicators of riba or interest ( such as LIBOR). Assuming that the minimum
return on the annual target by the financier (any Islamic Bank) is to achieve a
rate of 9.6% annual profit return and the total life of the project is five years,
then the total return is expected financier will get in such case is 48% (9.6%
× 5 years).
- A judging instrument to determine whether funding is allowed.
- An instrument to assist in designing and determining the targeted cash flows.
Accordingly; the proposed Model (MQAM) clearly shows the feasibility and
practicality of a substitute to LIBOR and as an evaluator instrument to proposed
investment projects.
We are stressing advise here to all practitioners working in the financial markets to
utilize and apply (MAQAM) to the test – side to side – with LIBOR, until MQAM
proves its effectiveness and practically shows its applicability.
The last of our prayer is: Praise be to Allah, the Lord of the worlds.
HAMA at 09/10/1431 HIJRI- 18/09/2010 A.D
those who wish further explanation can contact us via
Islamic Business Researches Center at:
http://www.kantakji.com/
Translated By:
The Scandinavian Centre for Translation and Documentation
23