SEMINAR ON DERIVATIVES IN ISLAMIC FINANCESEMINAR ON DERIVATIVES IN ISLAMIC FINANCE

“ISLAMIC PROFIT RATE SWAP –“ISLAMIC PROFIT RATE SWAP –ITS MECHANICS AND OBJECTIVES”ITS MECHANICS AND OBJECTIVES”

byby

Badlisyah Abdul GhaniBadlisyah Abdul Ghani

June 24, 2004

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CONTENTCONTENT

What is Interest Rate SwapWhat is Interest Rate Swap 11

Islamic Profit Rate Swap (IPRS) – DefinitionIslamic Profit Rate Swap (IPRS) – Definition 22

Objective of IPRSObjective of IPRS 33

The Dynamics of IPRSThe Dynamics of IPRS 44

How IPRS WorksHow IPRS Works 55

IPRS DocumentationIPRS Documentation 66

Status of DevelopmentStatus of Development 77

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WHAT IS AN INTEREST RATE SWAPWHAT IS AN INTEREST RATE SWAP

An Interest Rate Swap is an agreement to exchange interest rate cash flows, calculated on a notional principal amount, at specified intervals (payment dates) during the life of the agreement.

Each party’s payment obligation is computed using a different interest rate. In an interest rate swap, the notional principal is never exchanged. Swap typically refers to a generic interest rate swap in which one party pays a fixed rate and another pays a floating rate.

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ISLAMIC PROFIT RATE SWAP (IPRS) - DEFINITIONISLAMIC PROFIT RATE SWAP (IPRS) - DEFINITION

An Islamic Profit Rate Swap is an agreement to exchange profit rates

between a Fixed Rate Party and a Floating Rate Party or vice versa

implemented through the execution of a series of underlying contracts

to trade certain assets under the Shariah principles of Bai’ and Bai’

Bithaman Ajil.

Each party’s payment obligation is computed using a different pricing

formulae. In an Islamic profit rate swap, the notional principal is

never exchanged as it is netted off. Swap typically refers to the

difference in the price over and above the notional principal in which

one party pays a fixed rate and another pays a floating rate.

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OBJECTIVES OF IPRSOBJECTIVES OF IPRS

to match funding rates with return rates (from investment);

to achieve lower cost of funding;

to restructure existing debt profile without raising new finance, or

altering the structure of the balance sheet;

to manage exposure to interest rate movement as Islamic financial

institutions still compete with conventional banks for market space;

to deepen Islamic Financial Market.

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Receives fixed returns

THE DYNAMICS OF IPRSTHE DYNAMICS OF IPRS

CIMBCIMBFinancial Liabilities

Financial Liabilities

Financial Assets

Financial Assets

Islamic Swap Counter PartyIslamic Swap Counter Party

Receives floating profit rate

Pays floating obligations

Pays fixed profit rate

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HOW IPRS WORKSHOW IPRS WORKS

STAGE 1: Fixed Profit Rate

CIMBCIMB

Islamic Swap Counter PartyIslamic Swap Counter Party

ASSETASSET

STEP 1STEP 1 CIMB sells Asset to CIMB sells Asset to

Islamic Swap counter Islamic Swap counter Party at notional Party at notional

principal of RM500k. principal of RM500k.

STEP 2Islamic Swap Counter Party

sells Asset to CIMB at notional principal RM500k + mark-up based on fixed

profit rate

STEP 3Notional principal

amount of RM500k owed by both CIMB and

Islamic Swap party to each other is set off

STEP 4 STEP 4 The net difference i.e. the fixed The net difference i.e. the fixed profit rate in Step 2 is paid to profit rate in Step 2 is paid to

Islamic Swap counter Party by Islamic Swap counter Party by CIMB at the agreed interval CIMB at the agreed interval payment date of say 6 monthpayment date of say 6 month

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HOW IPRS WORKSHOW IPRS WORKS

STAGE 2: Floating Profit Rate

ASSETASSET

CIMBCIMB

STEP 1STEP 1 CIMB sells Asset to CIMB sells Asset to

Islamic Swap counter Islamic Swap counter Party at notional Party at notional

principal RM500k + principal RM500k + floating profit rate.

STEP 2Islamic Swap counter Islamic Swap counter

PartyParty sells Asset to CIMB at notional

principal of RM500k.

STEP 3Notional principal

amount of RM500k owed by both CIMB and

Islamic Swap party to each other is set off

STEP 4 STEP 4 The net difference i.e. the The net difference i.e. the

floating rate profit in Step 1 is floating rate profit in Step 1 is paid to CIMB by Islamic paid to CIMB by Islamic

Swap counter Party at the Swap counter Party at the agreed interval payment date agreed interval payment date

of say 6 monthof say 6 month

Islamic Swap Counter PartyIslamic Swap Counter Party

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HOW IPRS WORKSHOW IPRS WORKS

STAGE 3 – Determination of Subsequent Floating Rate

ASSETASSET

CIMBCIMB

Floating Profit Rate (Stage 2) is repeated every 6 months until maturity.

6 MONTHS6 MONTHS 6 MONTHS6 MONTHS 6 MONTHS6 MONTHS 6 MONTHS6 MONTHS MATURITYMATURITY

Islamic Swap Counter PartyIslamic Swap Counter Party

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IPRS DOCUMENTATIONIPRS DOCUMENTATION

Islamic Swap Master Agreement

Asset Purchase Agreement (fixed)

Asset Sale Agreement (fixed)

Asset Purchase Agreement (floating)

Asset Sale Agreement (floating)

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STATUS OF DEVELOPMENTSTATUS OF DEVELOPMENT

Secured approval from the National Shariah Advisory Council

(NSAC) of BNM on structure subject to documentation

On-going discussion with the International Swap and Derivatives

Association for regional/global standardisation

Finalising Malaysian documentation for submission to NSAC

targeted in July/August 2005

To be launched in Malaysia as industry wide Islamic product in 4th

quarter 2005

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Contact DetailsContact Details

CIMB IslamicCommerce International Merchant Bankers Berhad

10th Floor, Bangunan CIMB

Jalan Semantan, Damansara Heights

50490 Kuala Lumpur, MALAYSIA

Tel : +603 2084 8888/+603 2084 9666

Fax : +603 2093 0685

www.cimb.com.my