Chapter – 7
ISLAMIC BONDS
True / False Questions
1. Sukuk is an Arabic term for financial certificate, and is the Islamic equivalent
of a bond (asset-backed instruments).
Answer: True
Diff: 1
Page Ref: 257
LO: 1
2.
The AAOIFI defines sukuk as “certificates that represent the holder’s
proportionate ownership in an undivided part of an underlying asset where the
holder assumes all rights and obligations to such asset.”
Answer: False
Diff: 2
Page Ref:
LO: 1
3.
It is not a condition for sukuk holders to have interest or ownership in the
underlying asset.
Answer: False
Diff: 2
Page Ref: 257
LO: 1
4. Sukuk are singled as the best way of financing small enterprises.
Answer: False
Diff: 1
Page Ref: 259
LO: 1
5.
The process of modelling and structuring Islamic bonds requires a basic
knowledge of the major Islamic finance products such as mudarabah,
musharakah, ijarah, murabahah, wakalah, istisna’a.
Answer: True
Diff: 1
Page Ref: 262
LO: 2
6. There is only one type of sukuk regardless of the types of Islamic finance
products used in their structuring.
Answer: False
Diff: 2
Page Ref: 263
LO: 2
7.
Mudarabah sukuk are usually structured as an agreement between the rabb almal who provides the capital and the entrepreneur which may be an
investment company or a Special Purpose Vehicle (SPV).
Answer: True
Diff: 2
Page Ref: 265
LO: 2
8.
Risk mitigation in mudarabah sukuk is achieved through the process of
reinsurance.
Answer: False
Diff: 3
Page Ref: 265
LO: 2
9. The mudarabah sukuk holder is given the right to transfer the ownership by
selling the sukuk in the securities market at his/her discretion.
Answer: True
Diff: 2
Page Ref:266
LO: 2
10. The manager/ Special Purpose Vehicle (SPV) who receives the funds collected
from the subscribers to mudarabah sukuk can also invest his/her own funds.
Answer: True
Diff: 1
Page Ref: 267
LO: 2
11. It is not permissible under mudarabah sukuk agreement to create reserves for
contingencies, such as loss of capital, by deducting from the profit a certain
percentage in each accounting period.
Answer: False
Diff: 3
Page Ref: 267
LO: 2
12. The returns and losses on mudarabah sukuk are shared and borne in
accordance with the percentage of ownership of shares of each of the sukuk
holders.
Answer: False
Diff: 3
Page Ref: 268
LO: 2
13. The musharakah certificates are treated as nonnegotiable instruments that
cannot be bought and sold in the capital markets.
Answer: False
Diff: 3
Page Ref: 268
LO: 2
14. The musharakah certificate given to all sukuk holders represent their
proportion of ownership in the assets of the project being undertaken.
Answer: True
Diff: 1
Page Ref: 268
LO: 2
15. Under musharakah sukuk agreement, management of the business is the sole
responsibility of the entrepreneur.
Answer: False
Diff: 2
Page Ref: 270
LO: 2
16. The contract of ijarah has been used as a means of securitization of a tangible
asset such as a hospital or airport which allows the issuance of sukuk to
prospective investors.
Answer: True
Diff: 2
Page Ref: 272
LO: 2
17. The contract of ijarah has been structured in a manner that would allow for the
financing of short term small projects.
Answer: False
Diff: 2
Page Ref: 272
LO: 2
18. The holder of sukuk of ownership of services may not sublease such services
to a third party.
Answer: False
Diff: 2
Page Ref: 272
LO: 2
19. Islamic International Rating Agency (IIRA) has issued investment sukuk
standards which comprise of the definition, types, and characteristics of
investment sukuk (Standard No. 17).
Answer: False
Diff: 2
Page Ref: 274
LO: 3
20. AAOIFI standards contain the Sharī‘ah rulings and requirements on the
different types of sukuk as well as the prevailing practices in the secondary
markets.
Answer: True
Diff: 2
Page Ref: 274
LO: 3
21. The focus of the AAOIFI standards is the Islamic financial institutions or
corporate entities offering Islamic financial services such as sukuk.
Answer: True
Diff: 2
Page Ref: 274
LO: 3
22. The AAOIFI investment sukuk standards do extend to shares of stock
companies, certificates of funds, and investment portfolios.
Answer: False
Diff: 2
Page Ref: 274
LO: 3
23. The owners of the investment sukuk certificates share the return and bear no
losses of the business venture.
Answer: False
Diff: 1
Page Ref: 275
LO: 3
24. The Sharī‘ah rules and requirements as contained in the AAOIFI Standards of
sukuk are classified into (i) Sharī‘ah requirements in the issuance of
investment sukuk, and (ii) Sharī‘ah rules in trading in investment sukuk.
Answer:True
Diff:2
PageRef:275
LO: 3
25. The Sharī‘ah rules for trading in investment sukuk include the structuring and
classifications of the 16 different types of investment sukuk.
Answer: False
Diff: 1
Page Ref: 275
LO: 3
26. The designated grades for credit rating range from ‘AAA’ which is considered
as the lowest grade to ‘C’.
Answer: False
Diff: 1
Page Ref: 279
LO: 4
27. A key advantage of credit rating is that it allows potential investors to make
informed decisions before subscribing to debt securities.
Answer: True
Diff: 2
Page Ref: 279
LO: 4
28. The Islamic International Rating Agency (IIRA) which began operations in
2009 has since been striving to ensure the expansion of the Islamic finance
industry.
Answer: False
Diff: 2
Page Ref: 279
LO: 4
29. Islamic bonds can be rated on two bases: sovereign rating and country rating.
Answer: False
Diff: 1
Page Ref: 279
LO: 4
30. The risk level of the regulatory, political, economic and legal atmosphere
comprises a minimal factor in sovereign credit ratings.
Answer: False
Diff: 1
Page Ref: 279
LO: 4
31. Sovereign credit ratings are key features considered by foreign investors when
intending to invest abroad.
Answer: True
Diff: 1
Page Ref: 279
LO: 4
32. Corporate credit rating affects both the issuer and the issues.
Answer: True
Diff: 1
Page Ref: 283
LO: 4
33. The general rating of a country as a sovereign entity is carried out before the
rating of particular issue or institution.
Answer: True
Diff: 1
Page Ref: 283
LO: 4
34. Issuer rating has no impact on the credibility of the rated corporate entity.
Answer: False
Diff: 1
Page Ref: 284
LO: 4
35. The rating products in Islamic financial markets cover among others: bond/
sukuk ratings, bank’s financial strength ratings, and Sharī‘ah quality ratings.
Answer: True
Diff: 2
Page Ref: 283
LO: 4
36. The IIRA identified ‘sovereign ratings’ and ‘risk level ratings’ to be among
the eight major rating products in Islamic financial markets.
Answer: False
Diff: 2
Page Ref: 283
LO: 4
37. ‘Insurer financial strength ratings’ and ‘banks financial strength ratings’ are
among the eight major rating products in Islamic financial markets as
identified by IIRA.
Answer: True
Diff: 2
Page Ref: 283
LO: 4
38. The methodology adopted in the ratings of sovereign sukuk is purely
qualitative.
Answer: False
Diff: 3
Page Ref: 284
LO: 4
.The insurer ratings consider qualitative as well as quantitative factors .39
Answer: True
Diff: 2
Page Ref: 284
LO: 4
The rating of sukuk in the financial market is more important to the investors .40
than to the issuer.
.
Answer: False
Diff: 2
Page Ref: 284
LO: 4
41. IIRA adopts global financial practices in rating both the Islamic and
conventional financial institutions.
Answer: True
Diff: 2
Page Ref: 284
LO: 4
42. Banks financial strength ratings place emphasis on the ability of financial
institutions to make profits and pay dividends.
Answer: True
Diff: 1
Page Ref: 285
LO: 4
43. The Sharī‘ah quality rating aims at informing the investing public on the level
of compliance of certain corporate entities with the requirements of the
Sharī‘ah.
Answer: True
Diff: 1
Page Ref: 285
LO: 4
44. Best practices in the corporate governance rating of corporate entities are used
as benchmarks for the assessment rather than using the standards of particular
country or jurisdiction.
Answer: True
Diff: 3
Page Ref: 285
LO: 4
45. IIRA’s rating on real estate pertains to the rating of the individual projects
rather than to the overall rating of the developer.
Answer: False
Diff: 3
Page Ref: 286
LO: 4
46. The IIRA has two major categories of rating symbols: the international scale
ratings and the regional scale ratings.
Answer: False
Diff:
Page Ref:
LO:
______________________________________________
Multiple Choices Questions
are certificates of equal value representing undivided shares in the ____________ .1
ownership of tangible assets, usufructs and services or (in the ownership of) the assets
.of particular projects or special investment activity
a) alternative investments
b) Sukuk
c) Islamic stocks
d) charitable endowments
Diff: 2
Page Ref: 257
LO: 1
2. All the followings are benefits of sukuk EXCEPT:
a) sukuk is among the best ways of financing large enterprises
b) sukuk represent an excellent way of managing liquidity for banks and Islamic
financial institutions
c) sukuk enable investors to deploy small sums of capital without the ability to
liquidate their positions easily whenever the need should arises
d) sukuk are a means for the equitable distribution of wealth
Diff: 2
Page Ref: 259
LO: 1
3. Sukuk have been generally classified as:
a) tradable and non-tradable
b) short term and long term
c) debt based and equity based
d) A and C
Diff: 2
Page Ref: 263 - 264
LO: 2
4. The most common tradeable investment sukuk in use are
a)
sukuk al-mudarabah
b)
sukuk al-ijarah
c)
sukuk al-salam
d)
a and b
Diff: 2
Page Ref: 264
LO: 2
5. Trust Investment Bonds are also known as ________________.
a) sukuk al-mudarabah
b) sukuk al-mushrakah
c)
sukuk ali-jarah
d)
none of the above
Diff: 2
Page Ref: 264
LO: 2
6. The following rules are valid and must be followed when selling mudarabah sukuk
EXCEPT:
a) if the mudarabah capital is in the form of money, the trading of mudarabah
sukuk will be like the exchange of money for money and it must satisfy the rules of
bai‘ al Sarf
b) if the mudarabah capital is in the form of debt, it must be based on the principles
of debt trading in Islamic jurisprudence
c) mudarabah capital cannot be a combination of more than two types of
capital such as cash, receivables, goods, real assets and benefits
d) none of the above
Diff: 3
Page Ref: 266 - 267
LO: 2
7. Musharakah sukuk can be used for the mobilization of funds that can be used:
a)
for new project
b)
to develop an existing project
c)
to finance a huge business activity based on joint venture contracts
d)
all of the above
Diff: 2
Page Ref: 268
LO: 2
8. ______________ has been structured in a manner that would allow for the
mobilisation of funds for the development of long term infrastructure projects.
a)
the contract of ijarah
b)
the contract of musharakah
c)
the contract of wakalah
d)
the contract of mudarabah
Diff: 2
Page Ref: 270
LO: 2
9. Which of the following is not a form of ijarah sukuk?
a)
sukuk of ownership in leased assets
b) sukuk of ownership of usufructs of assets
c) sukuk of ownership of services
d) sukuk of ownership in leased with option to buy assets
Diff: 3
Page Ref: 272
LO: 2
10. ____________is issued with aim of conferring the right of usufruct in the sukuk
holders where they become joint owners.
a) sukuk of ownership in leased assets
b)
sukuk of ownership of usufructs of leased assets
c) sukuk of ownership of usufructs of assets
d) sukuk of ownership of services
Diff: 2
Page Ref: 272
LO: 2
11. This form of ijarah sukuk is issued to subscribers for the purpose of conferring the
ownership in such services to the sukuk holders:
a) sukuk of ownership in leased assets
b)
sukuk of ownership of services
c) sukuk of ownership of usufructs of assets
d) none of the above
Diff: 1
Page Ref: 272
LO: 2
12. The following statements regarding the AAOIFI Standards on Islamic Bonds are
true EXCEPT:
a) the standards contain the Sharī‘ah rulings and requirements on the different types
of sukuk as well as the prevailing practices in the secondary markets
b) the scope of the investment sukuk is clearly specified with the enumeration of the
fourteen types of Sukuk structures (Table 7.2 of the textbook)
c) the AAOIFI investment sukuk standards are extended to shares of stock
companies, certificates of funds and investment portfolios
d) the focus of the standards is the Islamic financial institutions or corporate entities
offering Islamic financial services such as sukuk
Diff: 3
Page Ref: 274
LO: 3
13. The following Sharī‘ah requirement(s) must be observed in the process of
issuance of investment sukuk:
a) it is not permissible to issue investment certificates, on the basis of any of
Sharī‘ah-compliant investment contracts
b) it is permissible to issue securities for trading in tangible assets, usufructs, or
services
c) the contract of issue must be governed, after closing date and allocation of the
certificates, by the interpretation of the issuer
d) the two parties of the contract of issue are the issuer and the management
Diff: 3
Page Ref: 275
LO: 3
14. Which of the following statements regarding rating agencies is/are true?
a) there are over 50 rating agencies that have been established across the world.
b) the leading global rating agencies include Moody's, Standard & Poor's, and Fitch
Rating.
c) the Islamic Development Bank (IDB) took the initiative to establish an
international rating agency known as the Islamic International Rating Agency (IIRA).
d) all of the above
Diff: 3
Page Ref: 279
LO: 4
15.
a)
b)
c)
d)
The two popular classifications of bonds while rating their quality are:
‘investment grade bonds’ and ‘junk bonds’.
‘sovereign grade bonds’ and ‘corporate bonds’
‘investment grade bonds’ and ‘sovereign grade bonds’
none of the above
Diff: 3
Page Ref: 279
LO: 4
16. Islamic bonds can be rated on two bases:
a) long term and short-term
b) sovereign and corporate
c) public and private
d) none of the above
Diff: 2
Page Ref: 279
LO: 4
17. Which of the following factors is not considered by ‘Euromoney Country Risks’
as essential in the ranking of countries by risk?
a) political risk
b) economic performance/projections
c) structural assessment
d) all of the above
Diff: 2
Page Ref: 281
LO: 4
18. Which of the following factors is considered by ‘Euromoney Country Risks’ as
essential in the ranking of countries by risk?
a) debt indicator and credit ratings
b) access to bank finance
c) access to capital markets
d) all of the above
Diff: 2
Page Ref: 281
LO: 4
19. The followings are basic categories used by IIRA in analysing sovereign sukuk
and the likelihood of any default on debt obligations at maturity EXCEPT:
a) politics and policy continuity
b) accessibility to capital markets
c) the economy –structure and growth prospects
d) budgetary and fiscal policy
Diff: 3
Page Ref: 281
LO: 4
20. Which of the following categories are used by IIRA in analysing sovereign sukuk
and the likelihood of any default on debt obligations at maturity?
a) monetary policy and flexibility
b) the external accounts
c) internal and external debt
d) all of the above
Diff: 3
Page Ref: 281
LO: 4
21. _______________ promote stability and sustainability in the financial industry.
a) corporate credit ratings
b) sovereign credit ratings
c) country risk ratings
d) credit ratings
Diff: 3
Page Ref: 283
LO: 4
22. In order for corporate entities to win the confidence of prospective investors, they
must:
a) reduce their risk level
b) demonstrate their ability to meet all financial obligations
c) offer their employees generous compensation packages
d) a and b
Diff: 1
Page Ref: 283
LO: 4
23. Corporate ratings in the Islamic financial markets involve:
a) bank’s financial strength ratings
b) Sharī‘ah quality ratings
c) corporate governance ratings
d) all of the above
Diff: 2
Page Ref: 283
LO: 4
24. _________________ comprises issuer and issue ratings where a reliable third
party gives an opinion on the feasibility of the repayment of the issuer or an issue of
its financial obligations within the record time.
a) issuer ratings
b) bond/sukuk ratings
c) sovereign ratings
d) Sharī‘ah quality ratings
Diff: 3
Page Ref: 283
LO: 4
25. The ratings of the issuer of sukuk places particular emphasis on:
a) the level of compliance of certain corporate entities with the requirements of the
Sharī‘ah.
b) the investment quality and/or credit worthiness
c) the issuer continued ability to fulfil its debt obligations to the stakeholders
particularly the investors
d) all of the above
Diff: 3
Page Ref: 284
LO: 4
26. Quantitatively, the strength of the balance sheet of the company and its operating
performance are methodically evaluated when instigating
a) issuer ratings
b) insurer financial strength ratings
c) corporate governance ratings
d) real estate ratings
Diff: 3
Page Ref: 284
LO: 4
:The main issue considered in the banks’ financial strength ratings is the .27
a) investment quality and/or credit worthiness
b) strength of the balance sheet of the bank
c) operating performance of the bank
d) rate of return on investment
Diff: 3
Page Ref: 284 - 285
LO: 4
28. The key subject headings in IIRA’s asset quality analysis are:
a) banking environment
b) risk management practices
c) lending history and performance
d) all of the above
Diff: 2
Page Ref: 285
LO: 4
29. Which of the following sets of fundamentals are considered in the assessment of
the banks’ financial strength?
a) market assessment
b) liquidity and funds management
c) capital adequacy
d) all of the above
Diff: 2
Page Ref: 285
LO: 4
30. Which of the following is not a set of fundamentals that are considered in the
assessment of the banks’ financial strength?
a) liquidity and funds management
b) asset/liability management
c) number of bank outlets
d) adjustments to achieve economic reality
Diff: 2
Page Ref: 285
LO: 4
31. Assessing the level of compliance of a financial institution or corporate entity
with the requirements of the Sharī‘ah include the following major element(s):
a) corporate governance framework
b) code of ethics adopted by the institution
c) monetary policy and flexibility
d) all of the above
Diff: 3
Page Ref: 285
LO: 4
32. Real estate rating is assigned after taking into account:
a) market characteristics
b) effectiveness of the top management team
c) liquidity and funds management
d) all of the above
Diff: 2
Page Ref: 286
LO: 4
33. The real estate rating methodology designed by IIRA evaluates:
a) all on-going projects of the developer
b) the developer’s activities such as the performance of its architects, engineers, and
contractors
c) the level of fairness, transparency, responsibility and accountability of the
developer
d) a and b
Diff: 3
Page Ref: 286
LO: 4
Short answer questions
Question 1
Discuss briefly the general benefits of sukuk as presented by Muhammad Taqi
Usmani.
According-to Muhammad Taqi Usmani, the general benefits of sukuk include:
 financing large enterprises that are beyond the ability of a single party to do so
 providing an ideal means for investors seeking to deploy streams of capital
and who require, at the same time, the ability to liquidate their positions with
ease whenever the need should arise
 representing an excellent way of managing liquidity for banks and Islamic
financial institutions (IFIs). When these need to dispose of excess liquidity
they may purchase sukuk; and when they are in need of liquidity, they may sell
their sukuk into the secondary market
 being a means for the equitable distribution of wealth as they allow all
investors to benefit from the true profits resulting from the enterprise in equal
shares.
Page Ref: 259
LO: 1
Question 2
What are the major differences between sukuk and bonds?
The major differences between sukuk and bonds are:
 while conventional bonds are contractual debt securities, sukuk represent the
undivided ownership of each of the sukuk holders in the underlying asset
 the return in conventional bonds is in the form of interest (coupon) and the
principal amount whereas in sukuk, the return is in the form of profits that are
paid out pro rata in accordance with the value of shares held by each sukuk
holder
 the contractual relationship between the issuer and the investors in sukuk is
simply a partnership and not a debtor and credit relationship, as in the case of
conventional bonds
 sukuk holders have ownership rights in the underlying asset, while
conventional bonds do not usually carry ownership rights in the asset
 sukuk must be asset-backed, while bonds may not necessarily be asset-backed.
Page Ref: 261-262
LO: 1
Question 3
Describe the most common classifications of the types of sukuk structures.
The most common classifications of the types of sukuk structures are:
1) Tradable and non-tradable sukuk
 tradable sukuk: Islamic investment certificates that represent tangible assets
or proportionate ownership of a business or investment portfolio. Examples of
these include sukuk al-ijarah, sukuk al-musharakah and sukuk al-mudarabah
 non-tradable sukuk: Investment certificates that represent receivables of cash
or goods. Examples of these include sukuk al-murabahah and sukuk al-salam
2) Equity-based and debt-based sukuk
 equity-based sukuk: Partnership-based Islamic investment certificates of
partnership contracts where the parties share the profits as well as any risk
arising from the investment activity
 debt-based sukuk: Investment certificates that are based on receivables such as
where the rights of the certificate holders are shares in the debt.
Page Ref: 264
LO: 2
Question 4
Describe how profits and losses are treated under mudarabah and musharakah
sukuk.
Any profits generated under mudarabah sukuk are distributed periodically according
to the predetermined ratio as contained in the underlying contract. The issuer pays the
sukuk holders in proportion to their individual shareholding in the capital invested. In
the case of any losses, the investors are solely responsible, unless it can be proved that
the loss was caused by negligence, mismanagement, or fraud on the part of the
entrepreneur.
On the other hand, under musharakah sukuk profits are distributed periodically
according to the predetermined ratio as contained in the underlying contract between
the issuer and the certificate holders. The issuer pays the investors/sukuk holders in
proportion to their individual shareholding in the business. In the event of any losses,
the parties share the risk burden in proportion to their respective capital contributions.
Page Ref: 268-270
LO: 2
Question 5
Describe the different variations of ijarah sukuk.
The different variations of ijarah sukuk are:
 sukuk of ownership in leased assets. This kind of ijarah sukuk is issued with
the sole aim of selling the asset to the sukuk holders through the transfer of
title. This form of ijarah sukuk can be used for the purchase of a new asset
 sukuk of ownership of usufructs of assets. In this case, the sukuk holders only
become the owners of the usufruct (manfaa) of the assets. The sukuk are
issued with the aim of conferring the right of usufruct to the sukuk holders
where they become joint owners
 sukuk of ownership of service. This form of ijarah sukuk is issued to
subscribers for the purpose of conferring ownership of services to the sukuk
holders. Such services are provided through a specified provider and the
ownership transferred to the sukuk holders, who may also sublease the services
to a third party.
Page Ref: 272
LO: 2
Question 6
Identify the AAOIFI’s five main characteristics of investment sukuk.
The main characteristics of investment sukuk are:
1. certificates represent the rights and the obligation of the owners
2. common share in the ownership of the underlying assets
3. share compliance
4. trading investment of investment sukuk and the rights they represent
5. returns and losses are commonly shared by certificate holders
Page Ref: 274 - 275
LO: 3
Question 7
What are the Sharī‘ah requirements for the issuance of investment sukuk?
The following Sharī‘ah requirements must be observed in the process of issuance of
investment sukuk.




any of the major Islamic modes of finance can be used to structure investment
sukuk
subscriptions can be made on the basis of any of the (14 types) of sukuk
the certificates must be issued to securitize tangible assets, usufructs, or
services. Debts owed or other receivables as a liability do not fall in the list of
permissible assets
there must be an underlying asset for the issuance of sukuk. The value of the
assets, usufructs, or services is divided into equal shares for the purpose of
issuing certificates to sukuk holders. The subscription funds must be used for a
Shari‘ah-compliant contract.
The contract of sukuk issuance between the issuer (SPV) and the subscribers
(sukuk holders), who are the main parties of the contract, is governed by all the rules
applicable to the contract type upon which the contract of issuance is based.
Page Ref: 275
LO: 3
Question 8
Describe the AAOIFI 2008 ruling on the sukuk tradability.
Sukuk, in order for them to be tradable, must be owned by the sukuk holders, together
with all of the rights and obligations that accompany such ownership. The manager of
a sukuk issuance must establish the transfer of ownership of such assets in its books
and must not retain them as its own assets.
Page Ref: 278
LO: 3
Question 9
What are the six basic categories used by IIRA to analyze sovereign sukuk and
the likelihood of any default on debt obligations at maturity?
The six basic categories used by IIRA to analyze sovereign sukuk and the likelihood
of any default on debt obligations at maturity are:
• politics and policy continuity
• the economy—structure and growth prospects
• budgetary and fiscal policy
• monetary policy and flexibility
• the external accounts
• internal and external debt
Page Ref: 281
LO: 4
Question 10
List the eight major rating products identified by the IIRA.
The IIRA identified the following eight major rating products:
• sovereign rating
• issuer rating
• bond/sukuk rating
• insurer financial strength rating
• bank financial strength rating
• Sharī‘ah quality rating
• corporate governance rating
• real estate rating
Page Ref: 283
LO: 4
Question 11
Explain the methodology employed in rating the issuer of sukuk.
In rating the sukuk issuer, the entity is rated with particular regards to its
creditworthiness and its continued ability to fulfill its debt obligations to stakeholders,
particularly investors. The overall financial and institutional creditworthiness of an
issuer will determine the level of confidence potential investors will have in it. Issuer
rating enhances the credibility of the corporate entity.
Page Ref: 284
LO: 4
Question 12
Identify the key elements considered by IIRA when assessing the level of
compliance of a financial institution or corporate entity with the requirements of
the Shari‘ah.
IIRA considers the following major elements in the assessment process : procedure of
authentication of products and services, safeguards against comingling of funds in the
case of an Islamic window or branch of a conventional financial institution, code of
ethics adopted by the institution, policy on the calculation of profit or loss and the
consequent sharing of same, whether the types of business undertaken are Sharī‘ah
-compliant or not, the Sharī‘ah compliance of both assets and liabilities, etc.
Page Ref: 285
LO: 5
Chapter – 8
ISLAMIC INSURANCE (TAKAFUL)
True / False Questions
1. Takaful is the Islamic alternative to conventional insurance, often translated as
‘Islamic insurance’.
Answer: True
Diff: 1
Page Ref: 293
LO: 1
2. The real concept of takaful relates more to a social security system run through
collaborative efforts of the people.
Answer: True
Diff: 2
Page Ref: 293
LO: 1
3. The three basic concepts of mutuality embodied in the takaful model of insurance are:
mutual help, mutual responsibility, and mutual financial interest.
Answer: False
Diff: 1
Page Ref: 293
LO: 1
3. Takaful industry is limited in its scope to Malaysia and the Middle Eastern Muslim
countries.
Answer: False
Diff: 1
Page Ref: 300
LO: 2
4. Literally, takaful means joint responsibility or guarantee based on mutual agreement.
Answer: True
Diff: 1
Page Ref: 293
LO: 1
5. Takaful is an alternative system of insurance where members contribute their financial
resources into a common pool based on the principles of profit-and-loss sharing
(PLS).
Answer: False
Diff: 2
Page Ref: 293
LO: 1
6. Mitigation of risk while carrying out commercial activities is not permissible in Islam.
Answer: False
Diff: 2
Page Ref: 294
LO: 1
7. Prohibitive elements in Islamic commercial transactions such as riba, gharar, and
maysir are also prohibited in the design of takaful models.
Answer: True
Diff: 1
Page Ref: 295
LO: 1
8. The concept of donations is adopted and merged with other frameworks of Islamic
commercial transactions to complement premiums.
Answer: False
Diff: 3
Page Ref: 295
LO: 1
9. Premiums paid by takaful policyholders are considered as donations towards the
common cause to assist those members who suffer any loss.
Answer: True
Diff: 2
Page Ref: 295
LO: 1
10. In Islamic law, the role of the operator of the cooperative insurance business is
integrated within the participants' role.
Answer: False
Diff: 1
Page Ref: 296
LO: 1
11. Islamic law restricts the role of the insurance company to merely an operator who is
appointed to manage the portfolio and invest the insurance contribution for and on
behalf of the participants.
Answer: True
Diff: 2
Page Ref: 296
LO: 1
12. Although the aim of takaful is to promote solidarity and cooperation among Muslims
under the principle of ta`awun, its initial objective remains to gain profit.
Answer: False
Diff: 1
Page Ref: 297
LO: 1
13. There are two main parties in the conventional insurance: the insurance company and
the operator.
Answer: False
Diff: 2
Page Ref: 297
LO: 1
14. The insured party in the conventional insurance has nothing to do with other insured
parties in terms of guaranteeing one another against any loss.
Answer: True
Diff: 1
Page Ref: 297
LO: 1
15. The parties in takaful are many and the participants insure one another against any
loss and this is carried out mutually.
Answer: True
Diff: 2
Page Ref: 297
LO: 1
16. Under takaful, the participants remain the owners of the premiums even though they
have donated them into a pool of funds to indemnify any member of the group.
Answer: True
Diff: 2
Page Ref: 298
LO:1
17. The model of takaful adopted by the stakeholders determines profit distribution as
well as remuneration of the takaful operator.
Answer: True
Diff: 2
Page Ref: 298
LO: 1
18. Despite the major difference between conventional insurance and takaful, there is no
restriction on the type of the business in which they can investment their funds.
Answer: False
Diff: 2
Page Ref: 298
LO: 1
19. The relationship between takaful operator and participants can be characterized as
insurer-insured relationship where each party assumes different roles and
responsibilities.
Answer: False
Diff: 2
Page Ref: 299
LO: 1
20. The first resolution on the permissibility of takaful as a cooperative insurance was
issued by the Council of Saudi Scholars in 1977.
Answer: True
Diff: 1
Page Ref: 300
LO: 1
21. There is no need to restructure the takaful products since they are conventionally
viable and globally competitive as they are.
Answer: False
Diff: 2
Page Ref: 300
LO: 1
22. Partnering with international giants in offering of takaful products in Europe and
America is a viable strategy to penetrate the global insurance market.
Answer: True
Diff: 3
Page Ref: 301
LO: 1
23. Takaful operators need to diversify their products to include new areas such as
medical insurance and introduce challenging frameworks to address complex risk
issues.
Answer: True
Diff: 2
Page Ref: 301
LO: 1
24. The main two parties involved in the implementation of the takaful system are the
issuer and the participants.
Answer: False
Diff: 1
Page Ref: 302
LO: 2
25. When the participants’ investment fund (PIF) is invested in Sharī‘ah-compliant
business, the profit shared between the takaful operator and the participants based on
a pre-agreed ratio.
Answer: True
Diff: 3
Page Ref: 302
LO: 2
26. The funds contributed by the participants under the mudarabah model of takaful are
divided into Participants’ Risk Fund (PRF) and Participants’ Investment Fund (PIF).
Answer: True
Diff: 1
Page Ref: 302
LO: 2
27. It is safe to claim that the mudarabah model of takaful is gaining grounds in the
industry despite the advent of the wakalah model.
Answer: False
Diff: 2
Page Ref: 303
LO: 2
28. Under the wakalah model of takaful, the takaful operator does not share in any risk
borne in the investment or management of the takaful fund.
Answer: True
Diff: 2
Page Ref: 305
LO: 2
29. The hybrid takaful model is a combination of the wakalah model and the murabahah
model where the wakalah model is employed for the underwriting purposes, and the
murabahah model is utilised for the investment activities.
Answer: False
Diff: 2
Page Ref: 305
LO: 2
30. AAOIFI recommends the hybrid model for takaful companies.
Answer: True
Diff: 1
Page Ref: 305
LO: 2
31. The ultra-hybrid model of takaful is hybrid of the wakalah and waqf models.
Answer: False
Diff: 1
Page Ref: 306
LO: 2
32. The available products in the takaful industry have been generally classified into three
main products –general takaful and family takaful, and community takaful.
Answer: False
Diff: 1
Page Ref: 310
LO: 3
33. General takaful and family takaful are Sharī‘ah-compliant alternatives to the
conventional life insurance and general insurance respectively.
Answer: False
Diff: 2
Page Ref: 310-312
LO: 3
34. General takaful is a short-term policy that covers assets and other proprietary
possessions of participants from probable material loss or any form of damage.
Answer: true
Diff: 2
Page Ref: 310
LO: 3
35. Underwriting surpluses of the takaful funds are distributed to the participants
quarterly.
Answer: False
Diff: 2
Page Ref: 310
LO: 3
36. Family takaful is the Sharī‘ah-compliant alternative to life insurance.
Answer: True
Diff: 1
Page Ref: 310
LO: 3
37. Ordinary collaboration takaful entails that premiums paid by the participant are used
for underwriting activities in the event of any misfortune or disaster on the part of any
of the members of the group.
Answer: True
True Diff: 2
Page Ref: 312
LO: 3
38. A significant advantage of ‘collaboration with savings’ plan is that participant’s
benefit collectively from the common pool of funds they mutually contribute through
tabarru’.
Answer: True
Diff:2
Page Ref: 312
LO: 3
39. AAOIFI is yet to issue a standard that provides for the necessary disclosure of the
bases for determining and allocating surplus or deficit in takaful companies.
Answer: False
Diff: 1
Page Ref: 314
LO: 4
40. The underwriting surplus is calculated by deducting all indemnities paid for deserving
claims, the retakaful policy, and changes in technical provisions from the total
premium contributions of the participants.
Answer: True
Diff: 1
Page Ref: 314
LO: 4
41. The management team collectively has exclusive right to the surplus originated from
the takaful policyholders who made the financial contributions.
Answer: False
Diff: 2
Page Ref: 314
LO: 4
42. The shareholders will get reimbursed from the profit realised from the investment
activities of the takaful undertaking.
Answer: True
Diff: 3
Page Ref: 315
LO: 4
43. The takaful operator may provide a qard hasan (benevolent loan) to the takaful fund
to carry out the underwriting activities in order to cover any deficit in the takaful
undertakings.
Answer: True
Diff: 2
Page Ref: 316
LO: 4
44. The two main funds in the takaful undertaking are Participants’ Investment Fund
(PIF) and Participants’ Management Funds (PMF).
Answer: False
Diff: 2
Page Ref: 316
LO: 4
45. Deficit occurs when the takaful claims of the participants are less than the pool of
funds for underwriting activities.
Answer: False
Diff: 1
Page Ref: 316
LO: 4
46. It is the duty of the takaful participants to rectify the deficiency and loss in the
Participants’ Risk Funds (PRF) initially by asking policyholders to meet the deficit
pro rata.
Answer: False
Diff: 2
Page Ref: 316
LO: 4
47. Recorded losses in the Participants’ Investment Fund (PIF) shall be absorbed by the
capital providers (the participants).
Answer: True
Diff: 2
Page Ref: 317
LO: 4
48. Within the conventional framework of insurance, the pool of risks of insurance
companies is transferred to a larger company where the reinsurer reinsures the risks
through a process of reinsurance.
Answer: True
Diff: 1
Page Ref: 317
LO: 5
49. The main risk management technique for takaful operators is reinsurance where their
risks are underwritten by the reinsurer.
Answer: False
Diff:
Paged Ref:
LO:
50. Retakaful, which has been structured in a Sharī‘ah-compliant model, is the Islamic
alternative to conventional reinsurance.
Answer: True
Diff: 1
Paged Ref: 317
LO: 5
51. Sharī‘ah scholars prohibit the takaful operators to reinsure with conventional
reinsurance companies regardless of any given justification.
Answer: False
Diff: 2
Page Ref: 319
LO: 5
52. The capital of many of the retakaful companies is so large enabling them to attain an
“A” rating which is mostly required for reinsurance purposes.
Answer: False
Diff: 2
Page Ref: 318
LO: 5
Multiple Choices Questions
1.
a)
b)
c)
d)
The basic concept(s) of mutuality that is/are embodied in the takaful model of
insurance include:
mutual help
mutual responsibility
mutual protection
all of the above
Diff: 2
Page Ref: 293
LO: 1
2. Takaful is an alternative system of insurance where members contribute their financial
resources into a common pool based on the principles of:
a) ta’awun (mutual assistance) and tabarru’ (donation)
b) profit and loss sharing
c) business partnership
d) all of the above
Diff: 2
Page Ref: 293
LO: 1
3. The noble hadith of Prophet Mohammed peace be upon him ‘tie your camel first’
typifies the importance of:
a) taking all possible precautions while carrying out commercial as well as other civil
activities then relying on the Almighty Allah for protection
b) getting insurance cover against market risks and losses
c) putting in place appropriate measures of risk management while carrying out
commercial activities
d) all of the above
Diff: 3
Page Ref: 294
LO:1
4. The following features are unique to takaful EXCEPT:
a) cooperative risk sharing
b) profit and loss sharing
c) clear financial segregation
d) Sharī‘ah-compliant policies and strategies
Diff: 1
Page Ref: 295
LO: 1
5. In the conventional practice of insurance business:
a) the insurance company is a profit-making entity which agrees to bear the financial
burden and losses of its policyholders
b) the shareholders own the company and are entitled to receive any profit and bear the
burden of any deficit recorded at the end of the financial year
c) there is no restriction in investment of funds
d) all of the above
Diff: 2
Page Ref: 296
LO: 1
6.
a)
b)
c)
d)
The number of parties involved in takaful are:
two
three
many
none of the above
Diff: 3
Page Ref: 297
LO:1
7. Takaful premiums are:
a) considered as trust held by the operator on behalf of the participants
b) paid in return for an insurance cover
c) recognized as deposits that must be returned to the participants at the end of business
year
d) all of the above
Diff: 3
Page Ref: 298
LO: 1
8. The modern history of takaful dates back to 1979 when:
a) Islamic-Arab Insurance Company was established in Saudi Arabia and later in United
Arab Emirates
b) the Islamic Insurance Company was established in Sudan and offered its takaful
based on the cooperative insurance model
c) Malaysia enacted the Takaful Act which provides for the regulation of takaful
business in Malaysia and other incidental matters
d) the OIC Fiqh Academy approved the takaful system
Diff: 3
Page Ref: 300
LO: 1
9. Which of the following is NOT a model of takaful?
a) the Mudarabah Model
b) the Wakalah Model
c) hybrid Wakalah-cum-Mudarabah Model
d) none of the above
Diff: 2
Page Ref: 302
LO: 2
10. Under the mudarabah model of takaful, the funds contributed by the participants into
the common pool of funds, which is used for underwriting purposes, is known as:
a) Participants’ Risk Fund (PRF)
b) Participants’ Investment Fund (PIF)
c) Participants’ Retirement Fund (PRF)
d) Participants’ Management Fund (PMF)
Diff: 3
Page Ref: 302
LO: 2
11. ___________________ is based on the contract of agency between the takaful
participants and the takaful operator where the takaful participants are the real owners
of the fund, and the takaful operator acts as an agent.
a) the Mudarabah Model of takaful
b) the Wakalah Model of takaful
c) hybrid Wakalah-cum-Mudarabah Model of takaful
d) wakalah with Waqf Model of takaful
Diff: 2
Page Ref: 303
LO: 2
12. IFSB-8 suggests that the agency (wakalah) fee should cover the total sum of the
following costs:
a) management expenses
b) distribution costs, including intermediaries’ remuneration
c) a margin of operational profit to the takaful operator.
d) all of the above
Diff: 2
Page Ref: 305
LO: 2
13.
a)
b)
c)
d)
The followings are lawful sources of income of the Takaful Operator EXCEPT:
agency fee
incentive fee
fixed percentage of the total investment funds
the profit share from the investment of the funds
Diff:3
Page Ref: 305
LO: 2
14. ______________________ is also called “the mixed model”.
a) The hybrid takaful model
b) The Mudarabah – Musharakah Model
c) The Wakalah Model
d) Wakalah with Waqf Model
Diff: 2
Page Ref: 306
LO: 2
15. This new takaful model was introduced by the renowned Sharī‘ah scholar Muhammad
Taqi Usmani the Chairman of the AAOIFI:
a) the Hybrid takaful model
b) the Mudarabah Model
c) the Wakalah Model
d) the Ultra-hybrid Model of Takaful
Diff: 2
Page Ref: 306
LO: 2
16. ___________________is a short-term policy renewable periodically according to the
terms and conditions of the takaful contract.
a) general takaful
b) general insurance
c) family takaful
d) life insurance
Diff: 2
Page Ref: 310
LO: 3
17. The followings are examples of general takaful covers EXCEPT:
a) machinery breakdown
b) fire Takaful
c) permanent disability takaful
d) workmen Compensation takaful
Diff: 3
Page Ref: 310
LO: 3
18. Health Takaful is an example of:
a) social takaful
b) general takaful
c) family takaful
d) community takaful
Diff: 2
Page Ref: 310
LO: 3
19
a)
b)
c)
d)
e)
Examples of family takaful include:
accidental death
savings and education plans for one’s dependants
disability plans
all of the above
a and c
Diff: 2
Page Ref: 312
LO: 3
20. __________________ is not one of the three types of family takaful.
a)
b)
c)
d)
Ordinary collaboration
Collaboration based on specific issues
Collaboration with savings
Collaboration based on specific groups
Diff: 2
Page Ref: 312
LO: 3
21. Which of the following characteristics is NOT true regarding the family takaful?
a) it is usually offered as a long-term policy cover that may span between 5 and 10
years depending on the structure of the product
b) family takaful cover involves life and family issues
c) collaboration with savings is one of the three types of family takaful
d) examples of family takaful include retirement plans
Diff: 2
Page Ref: 310-312
LO: 3
22. This type of family plan is usually structured in a manner that reflects communal,
ethnic, or organisational needs:
a) collaboration based on specific groups
b) ordinary collaboration
c) collaboration based on special issues
d) collaboration with savings
Diff: 2
Page Ref: 312
LO: 3
23. AAOFI identifies the following method(s) of allocating takaful surplus:
a) allocation of surplus to all shareholders
b) allocation of surplus only among policyholders who have not made any claims
during the financial period
c) allocation of surplus to all policyholders and management
d) all of the above
Diff: 3
Page Ref: 315-316
LO: 4
24. AAOIFI proposes the following method(s) of covering the takaful deficit:
a) to settle the deficit from the reserves of policyholders, if any
b) to borrow from the shareholders’ funds or from others the amount of deficit that
should be paid back from future surpluses
c) to increase the future premium contribution of policyholders on a pro-rata basis
d) all of the above
Diff: 2
Page Ref: 316
LO: 4
25. In situations where it is clear that the deficit in the in Participants Risk Fund (PRF) is
due to the negligence or mismanagement of the takaful operator, such deficit may be
rectified:
a) through the transfer of assets from the shareholders’ fund
b) through the borrowing from the shareholders’ funds the amount of deficit that should
be paid back from future surpluses
c) by asking the policyholders to meet the deficit pro rata
d) by increasing the future premium contribution of policyholders on a pro-rata basis
e) all of the above
Diff: 3
Page Ref: 317
LO: 4
26. When a deficit is recorded in the PIF, the losses will be:
a) absorbed by the capital providers
b) rectified through qard hasan
c) by asking the policyholders to meet the deficit pro rata
d) all of the above
Diff: 3
Page Ref: 317
LO: 4
27. Which of the following statements are true with regard to reinsurance?
a) the reinsurance operation is subject to riba and gharar
b) insurable interest is vested in the reinsured party
c) reinsurance is a mechanism of the mitigation of great risks by transferring the risks to
a large insurer known as reinsurer
d) all of the above
Diff: 2
Page Ref:318
LO: 5
28. Modern Sharī‘ah scholars:
a) permit takaful operators to undertake reinsurance policies with conventional
reinsurance companies
b) permit takaful operators to undertake reinsurance policies with conventional
reinsurance companies under certain conditions
c) do not permit takaful operators to undertake reinsurance policies with conventional
reinsurance companies under any condition
d) allow takaful operators to reinsure with conventional reinsurance companies only once
a year
Diff: 3
Page Ref: 318-319
LO: 5
Short answers
Question 1
What are the major differences between takaful and conventional insurance?
There are certain elements in conventional insurance that are unlawful in Sharī‘ah and thus
contradict fundamental precept. These elements are the source of major differences between
takaful and conventional insurance. The major differences between the two frameworks are
parties to the contract, payment of premiums, and investment of insurance funds.
Page Ref: 296
LO: 1
Question 2
Discuss briefly the three core principles of takaful.
The main features of takaful are based on the following core principles:
1. Tabarru’ (donation/contribution) commitment. Tabarru’ is an Islamic concept of
donation or charitable contribution that is primarily targeted at assisting others. Each
takaful participant makes this commitment to fulfill the objective of mutual assistance
through premiums.
2. Ta’awun or mutual assistance. Participants agree to mutually indemnify one another
in the event of losses arising from an unforeseen event. While the Islamic form of
cooperative or mutual assistance is not averse to profit-making, the primary objective
of the scheme is to assist one another based on the concept of ta’awun as chiefly
documented in the Qur’an and the Sunnah.
3. Prohibition of riba (usury), gharar (excessive risk or uncertainty), and maysir
(gambling or speculation). The takaful operator, who technically manages and
oversees the takaful funds, must consider the mandatory prohibitions in commercial
transactions when making investment decisions.
Any takaful scheme structured upon a combination of the three core principles described
satisfies the basic requirements of the Sharī‘ah.
Page Ref: 296-297
LO: 1
Question 3
Among the major differences between takaful and conventional insurance is the parties
to the contract. Briefly discuss.
There are two main parties in conventional insurance, i.e. the insurance company and the
insured party. The insured party has nothing to do with other insured parties in terms of
guaranteeing one another against any loss. The insured party is only concerned about itself.
Conversely, the parties in takaful are many. The participants in the takaful scheme mutually
insure one another against any loss. The takaful operator cannot claim to be the insurer
because it only acts as the administrator of the funds in accordance with the Sharī‘ah. The
participants insure themselves against any loss based on mutual agreement and a mutual
sense of responsibility.
Page Ref: 296-297
LO: 1
Question 4
Explain the mudarabah model of takaful.
The wakalah model of takaful has the following steps:
1. Participants contribute to the common poll of funds where:
- Part of such funds is invested as PIF
- The other part of the participants’ contribution is the PRF which is used to
settle claims, retakaful purposes and reserves
2. When the PIF is invested in Sharī‘ah-compliant business, the profit is shared among
the takaful operator and the Participants based on a pre-agreed ratio
3. The shareholders’ funds comprise profits, dividends and management expenses. The
shareholders get their dividends from the takaful company (from the profit realised by
the company after deducting operating expenses)
4. A performance fee may be paid to the takaful operator for prudent management of the
fund.
Page Ref: 304
LO: 2
Question 5
Identify the steps in the hybrid takaful model (the mixed model).
The five steps in the hybrid takaful model are:
1. The participants appoint the takaful operator as an agent, for a mutually agreed fee
2. The takaful contribution is divided into the PIF and PRF
3. The investment profit from the PIF, based on the mudarabah model, is shared
between the participants and the takaful operator
4. The investment profit from PRF is added to the PRF account, which is used for
underwriting activities
5. Any profits and underwriting surplus may be distributed to the participants.
Page Ref: 305-306
LO: 2
Question 6
Define, give examples, and list the types of family takaful.
Definition: Family takaful is the Sharī‘ah alternative to life insurance, whereby people come
together to mutually indemnify one another against any disaster that may befall any member
of their family, such as sudden death or permanent disability.
Examples: Accidental death, savings and education plans for one’s dependants, retirement
plans, disability plans, or waqf plans.
Types:
 Ordinary collaboration
 Collaboration with savings
 Collaboration based on specific groups.
Page Ref: 310-312
LO: 3
Question 7
Describe the methods used in allocating the takaful surplus.
AAOIFI identifies the following methods of allocating takaful surplus
1. Allocation of surplus to all policyholders, regardless of whether or not they have
made claims on the policy during the financial period
2. Allocation of surplus only among policyholders who have not made any claims during
the financial period
3. Allocation of surplus among those who have not made any claims and among those
who have made claims of amounts less than their insurance contributions, provided
that the latter category of policyholders should receive only the difference between
their insurance contributions and their claims during the financial period
4. Allocation of surplus between policyholders and shareholders
5. Allocation of surplus by using other methods
* These methods are not cumulative but alternatives among which the takaful undertaking
may select its specific method
*AAOIFI proposes that when the takaful policy or by-laws is silent on the specification of
allocation methods, the first method listed above should apply - whereby all policyholders
will benefit equally from the surplus.
Page Ref: 315-316
LO: 4
Question 8
Identify the AAOIFI proposed methods for covering the takaful deficit.
AAOIFI generally proposes in its relevant standard the following methods for covering the
takaful deficit.
1. To settle the deficit from the reserves of policyholders, if any
2. To borrow from the shareholders’ fund or from others the amount of deficit, which
3. Should be paid back from future surpluses
4. To ask the policyholders to meet the deficit pro rata
5. To increase the future premium contribution of policyholders on a pro-rata basis.
Page Ref: 316
LO: 4
Question 9
What are the methods proposed by AAOIFI for covering the takaful deficit?
AAOIFI generally proposes in its relevant standard a number of methods for covering the
takaful deficit.
 To settle the deficit from the reserves of policyholders, if any

To borrow from the shareholders’ fund or from others the amount of deficit, which
should be paid back from future surpluses

To ask the policyholders to meet the deficit pro rata
 To increase the future premium contribution of policyholders on a pro-rata basis.
Page Ref: 316
LO: 4
Question 10
Explain the risk aversion method of retakaful.
1.
The risk aversion method of retakaful is structured in a way where:
 Takaful operators are participants in a takaful undertaking with a large takaful
company.
 An agreed amount is paid periodically from the takaful fund of the operators as
premiums to the retakaful company
 With this premium, all the underwriting risks of the takaful operators are insured
by the retakaful company. In away, retakaful is a takaful undertaking for takaful
operators
2. The retakaful companies play a significant role when the takaful operators record
deficits or losses
3. The capital of many of the retakaful companies is not so large to attain an “A” rating
which is mostly required for reinsurance purposes
4. Sharī‘ah scholars have allowed the takaful operators to reinsure with conventional
reinsurance companies subject to certain conditions.
Page Ref: 317-319
LO: 5
Question 11
What are the differences between retakaful and reinsurance?
1) Riba and gharar
 A retakaful operation does not earn commission as a profit or interest, because this
commission is subject to riba and dilutes the purpose of setting up a takaful
operation
 The conventional reinsurance operation is subject to riba and gharar, which are not in
line with Sharī‘ah principles, e.g. the reinsurance commission that the direct
insurance company earns, from the reinsurance treaty
2) Principle of insurable interest
Because the retakaful operation is based on mudarabah, it is vested with a right to
reinsure on the insurer because permission from the policyholder is automatically
inherent in the contract of mudarabah
Although the reinsured party (direct insurance company) has no actual legal interest in
the property, the subject matter of the original insurance policy, it has assumed
responsibility for it, and has therefore put itself in a position, recognized by law,
in which it would be prejudiced by its loss.
Page Ref: 318
LO: 5
Chapter – 6
ISLAMIC ASSET AND FUND MANAGEMENT
True / False
1. Having a job is the preferred means for generating halal income and acquiring
wealth in Islam.
Answer: False
Diff: 2
Page Ref: 217
LO: 1
2. The necessity of financial planning and asset management is documented in Holy
Qur'an in order to prevent unforeseen economic recession at both the individual and
communal levels.
Answer: True
Diff: 2
Page Ref: 217
LO: 1
3.
Wealth in Islam is considered an end rather than a means to an end.
Answer: False
Diff: 1
Page Ref: 218
LO: 1
4.
A reduced interest rate to a minimal 0.1% is not prohibited in Islam since it is
not considered an excessive interest rate.
Answer: False
Diff: 2
Page Ref: 219
LO: 1
Financial returns on money must bear the two inseparable features of Islamic
.investing, i.e. fairness and profit
Answer: False
.5
Diff: 3
Page Ref: 219
LO: 1
6.
Speculative investment activities may involve both uncertainty (gharar) and
gambling (maysir), and both are prohibited in Islam.
Answer: True
Diff: 2
Page Ref: 220
LO: 1
7.
Islamic investing encompasses conventional insurance and derivatives.
Answer: False
Diff: 2
Page Ref: 220
LO: 1
8.
The uncertainty and contingency in contracts such as short selling and derivatives are permitted in Islam when they are properly streamlined to reflect the mandatory requirements of the Sharī'ah.
Answer: True
Diff: 3
Page Ref: 220
LO: 1
9. Wealth management involves investment and advisory services.
Answer: True
Diff: 2
Page Ref: 221
LO: 1
10.
Selection of Islamic stocks for investing involves a process of Sharī'ah
screening to ensure the compatibility of the stock with the permissible forms of
investments in the Sharī'ah.
Answer: True
Diff: 1
Page Ref: 221
LO: 2
11. A stock market index is used to measure fluctuations in the performance of
stocks in a financial market.
Answer: True
Diff: 2
Page Ref: 221
LO: 2
12. Securities are traded in a place called a financial stock exchange, where buyers
and sellers of securities trade in this organized supermarket.
Answer: False
Diff: 1
Page Ref: 222
LO: 2
.Stock Exchange market must be international in its scope .13
Answer: False
Diff: 2
Page Ref: 222
LO: 2
14. Among the most prominent Islamic indices are FTSC Global Islamic Index and
S&P Global Investable Sharī'ah Index.
Answer: True
Diff: 2
Page Ref: 222
LO: 2
15.
Generally, there is only one market index for all sectors of the economy in any
given country.
Answer: False
Diff: 3
Page Ref: 222
LO: 2
16. The major requirement in Islamic investment is Sharī'ah compliance at every
step of the investment selection process.
Answer:True
Diff: 1
Page Ref: 22
LO: 2
17.
There is a rule of thumb that applies in all cases on the screening methodology
for selecting Sharī'ah -compliant stocks.
Answer: False
Diff: 3
Page Ref: 224
LO: 2
The commonly used financial screening strategy determines the total
.debt/market capitalization to be less than 5%
.18
Answer: False
Diff: 2
Page Ref: 224
LO: 2
The commonly used financial screening strategy determines the total interest
.income/total revenues to be less than 30%
.19
Answer: False
Diff: 3
Page Ref: 224
LO: 2
20. The commonly used financial screening strategy determines the total account receivables/total assets to be less than 45%.
Answer: True
Diff: 2
Page Ref: 224
LO: 2
It is permissible for Islamic investment funds to engage in sale and repurchase
.(agreements (i.e., repos or buy-backs
Answer: False
Diff: 2
Page Ref: 226
LO: 2
.21
Islamic fund managers are allowed to speculate but not to undertake any
unnecessary risks
Answer: False
.22
Diff: 2
Page Ref: 226
LO: 2
23.
There is a common consensus among Muslim jurists that purification is required in all
capital gain earnings.
Answer: False
Diff: 2
Page Ref: 226
LO: 2
24.
Zakat may be used as a form of purification technique to dispose the portion of income
resulted from interest-related dealings.
Answer: True
Diff: 3
Page Ref: 226
LO: 2
25.
Sharī'ah compliance of firms that may engage in mergers, acquisition
or divestures, should be re-scrutinized periodically.
Answer: True
Diff: 3
Page Ref: 228
LO: 2
26.
The subscribers (investors) issue a form of certificate to the fund managers certifying their rate of subscription, which entitles them to pro-rata profits from the profits earned by the fund.
Answer: False
Diff: 1
Page Ref: 229
LO: 3
27.
The subscribers to the ijarah fund are issued certificates commonly
known as sukuk in Islamic finance.
Answer: True
Diff: 2
Page Ref: 231
LO: 3
Sukuk are negotiable instruments that cannot be traded in the secondary
.market
Answer: False
.28
Diff: 2
Page Ref: 231
LO: 3
29.
Commodity funds involve murabahah operations, iarah contracts or
bai bithaman ajil.
Answer: False
Diff: 1
Page Ref: 231
LO: 3
30.
In a commodity fund, the income realized from the resale of commodity is distributed pro-rated to the subscribers accordingly after deducting the
managerial expenses.
Answer: True
Diff: 3
Page Ref: 231
LO: 3
Islamic equity funds occupy a preferential position among the Islamic
.investment funds
Answer: True
Diff: 2
Page Ref: 232
LO: 3
.31
32.
Under the articles of mudarabah contracts, the investors (rabb al-mal)
assume the role of a silent partner while the fund managers (mudarib) as the
entrepreneurs perform the managerial functions.
Answer: True
Diff: 2
Page Ref: 233
LO: 3
33. The term “venture capital” covers only the financial capital required to
set up a firm.
Answer: False
Diff: 2
Page Ref: 234
LO: 3
34.
Usually, private equities engage in non-exchange traded or illiquid investment strategies.
Answer: True
Diff: 3
Page Ref: 234
LO: 3
35.
Private equities usually invest in a portfolio of growth companies and
tend to hold them for shorter time horizon.
Answer: False
Diff: 2
Page Ref: 234
LO: 3
36.
Conventional Venture Capital Funds are structured as closed-end
funds.
Answer: False
Diff: 3
Page Ref: 235
LO: 3
37.
Conventional Venture Capital Funds are usually invested in a pool of
venture capital projects thus allowing the benefits of diversification.
Answer: True
Diff: 3
Page Ref: 235
LO: 3
Under the structure of Islamic venture capital fund, individual and institutional
investors would act as the “general partners" while private equity experts are
.”considered as the “limited partners
Answer: False
.38
Diff: 3
Page Ref: 236
LO: 3
39.
Any clause or contractual term that does not contradict the Sharī'ah, regardless of its origin, will be accepted as being Sharī'ah-compliant.
Answer: True
Diff: 1
Page Ref: 236
LO: 3
40.
Mortgage REITs engage in a wide range of real estate activities, including leasing, development of real property and tenant services.
Answer: False
Diff: 2
Page Ref: 236
LO: 3
41.
The vast majority of modern Shari‘ah scholars believe it’s possible to have Islamic hedge funds.
Answer: False
Diff: 2
Page Ref: 237
LO: 3
The first Islamic hedge fund launched in the world is Altaquah US Equity
.42
Hedge Fund, in 1993 by Saudi Economic and Development Company (SEDCO) and
.the Permal Group
Answer: False
Diff: 2
Page Ref: 238
LO: 3
43. The conception of fund of funds may be a less efficient technique for Islamic funds due to the number of Islamic funds as well as the higher commissions and fees involved.
Answer: True
Diff: 3
Page Ref: 238
LO: 3
44.
Islamic Venture Capital Funds and equity funds are the most prominent investment techniques in Islamic investment.
Answer: False
Diff: 2
Page Ref: 238
LO: 3
Islamic fund management, as an infant industry, is going through
.45
a transitional phase in terms of its functional structure, marketing, and distribution
.systems
Answer: True
Diff: 2
Page Ref: 238
LO: 3
46. Islamic investment funds may enter into joint venture agreements with
other Islamic banks or conventional banks to create newer exposure to
prospective investors in other geographical locations.
Answer: True
Diff: 3
Page Ref: 239
LO: 3
47. Franchising is not recommended between Islamic funds and other Islamic financial institutions.
Answer: False
Diff: 2
Page Ref: 239
LO: 3
48.
AAOIFI requires a minimum of FIVE members for the Sharī'ah supervisory board.
Answer: False
Diff: 1
Page Ref: 242
LO: 4
49. Whether an institution has a board or a single supervisor is its own
choice.
Answer: True
Diff: 2
Page Ref: 242
LO: 4
50. Any prospective new product should be cross-checked for Sharī'ah compliance
in the first instance by the product development manager and then followed by the
board of directors.
Answer: False
Diff: 3
Page Ref: 242
LO: 4
51.
Each and every member of the Sharī'ah board should be compensated in the
same manner to avoid conflict of interest.
Answer: True
Diff: 1
Page Ref: 244
LO: 4
52.
In addition to the regular disclosure of financial reporting and other management information, Islamic funds require the disclosure of Sharī'ah compliance information.
Answer: True
Diff: 1
Page Ref: 244
LO: 4
53.
Islamic fund managers essentially replicate some of the basic risk management strategies applied in conventional investment funds.
Answer: True
Diff: 2
Page Ref: 245
LO: 5
54.
Basically, there are no additional risk management issues associated
with the Islamic funds and their products.
Answer: False
Diff: 1
Page Ref: 245
LO: 5
55.
The Risk-reward Profile ratio is calculated by dividing the amount the investor stands
to lose in such investment (i.e. the risk) by the profit the investor expects to make (i.e. the reward) as follows:
Risk $
----------------- = Risk-reward Profile Ratio
Reward $
Answer: False
Diff: 3
Page Ref: 245
LO: 5
The Sharī'ah advisory board must guide potential investors to the best product
.according to the prevailing market indices
Answer: False
.56
Diff: 3
Page Ref: 245
LO: 5
57.
Liquidity risk for investment funds arises from price volatility of the securities
under investment.
Answer: False
Diff: 3
Page Ref: 246
LO: 5
58. An effective investment strategy for Islamic fund managers is to diversify their
portfolio in terms of industrial sectors or geographical concentrations.
Answer: True
Diff: 2
Page Ref: 246
LO: 5
59.
In recent times, some murabahah- and arbun-based solutions have been applied to mitigate risk exposure in currency, equity and commodity funds.
Answer: True
Diff: 3
Page Ref: 246
LO: 5
60.
One important liquidity issue that Islamic fund managers face is the investment exit strategy.
Answer: True
Diff: 2
Page Ref: 247
LO: 5
61.
Due to the surplus of liquidity in the Islamic fund market, Islamic Fund managers are protected against the possibility of higher cash out-flow during the downward markets when individual investors may wish to liquidate their position.
Answer: False
Diff: 3
Page Ref: 247
LO: 5
Multiple Choice Questions
All of the following statements about the attitude of Islam towards income and
:wealth are true EXCEPT
a) human beings, as the owners of the earth's resources, have the free will
to utilize the earth and its endowments as they wish
b) Islam encourages exerting effort to own wealth through legitimate
investment
c) productive business activities are the preferred means for generating halal
income and acquiring wealth
d) Muslims prefer Sharī'ah-compliant investments in order to purify their
wealth and comply with their religious beliefs
Diff: 1
Page Ref: 217
LO: 1
:All of the following are fundamentals of Islamic investing EXCEPT .2
a) the exclusion of all interest-bearing (riba) products, services or investment
b) avoiding speculative investments
c) no risk
d) socially responsible / ethical investing
Diff: 1
Page Ref: 217
LO: 1
3.
The following forms of interest are prohibited in Islam under the prohibition
rule:
A
fixed or floating
b)
simple or compound
c)
“nominal” or “excessive”
d)
all of the above
Diff: 1
Page Ref: 219
LO: 1
?Which of the following statement(s) about Islamic investing is/are true
a)
there is a serious emphasis on ethical investing in Islam
.4
.1
b)
c)
d)
financial returns on money must bear the two inseparable features of
Islamic investing, i.e. fairness and socio-economic justice
conventional insurance and derivatives are permissible in Islamic
investing
all of the above
Diff: 2
Page Ref: 219
LO: 1
5.
Fund managers must do all the following EXCEPT:
a)
ensure that their clients’ investments are free from all forms of interestbearing products
b)
respect the specific requirements of Muslim investors who prefer
Sharī'ah-compliant products
c)
promise their clients an acceptable rate of return on their
investments
d)
must ensure that the contractual terms agreed with their clients conform to the principles of Islamic law
Diff: 2
Page Ref: 220 - 221
LO: 1
6.
All of the following are mechanisms for fulfilling social obligation EXCEPT:
a)
zakat (compulsory alms)
b)
sadaqah (voluntary alms)
c)
musharakah mutanaqisah (diminishing musharakah)
d)
takaful (Islamic cooperative insurance)
Diff: 2
Page Ref: 220
LO: 1
7.
_____________ were introduced to set benchmarks for Sharī'ah-compliant
products.
a)
financial standards
b)
Islamic indexes
c)
stock exchanges
d)
none of the above
Diff: 1
Page Ref: 221
LO: 2
8.
Which of the following is not an example of prominent International Stock
Exchanges?
a)
the Honk Kong Stock Exchange
b)
the London Stock Exchange
c)
the Kuala Lumpur Stock Exchange (KLSE)
d) Dubai Stock Exchange
Diff: 2
Page Ref: 222
LO: 2
9.
The most prominent Islamic indexes are:
a)
the Dow Jones Market Index
b)
FTSC Global Islamic Index
c)
S&P Global Investable Sharī'ah Index
d) all of the above
Diff: 2
Page Ref: 222
LO: 2
Industry screens for Sharī'ah compliance include
.10
a)
alcohol, tobacco, and pork-related products
b)
conventional financial services
c)
entertainment
d)
All of the above
Diff: 1
Page Ref: 222
LO: 2
11.
The investment selection process of stocks for Islamic investment funds go
through a systematic approach of:
a)
industry screen
b)
financial screen
c)
purification
d)
all of the above
Diff: 2
Page Ref: 222
LO: 3
12.
_________________ is a statistical method of measuring a section of the stock
market by compiling the share prices of representative stocks.
a)
stock exchange
b)
stock market index
c)
floating exchange rate
d)
return on investment
Diff: 2
Page Ref: 222
LO: 2
The Islamic investment selection process of Islamic funds include the following
:steps EXCEPT
a)
sector screen
.13
b)
financial screen
c)
assessment of the size of the fund to be invested
d)
purification of income distributions
Diff: 2
Page Ref: 222
LO: 2
Which of the following ratios regarding the frequently used financial screening
?strategy, as benchmark, is correct
a)
total debt/market capitalization < 33%
b)
interest income/total revenues < 5%
c)
account receivables/total assets < 45
d)
all of the above
.14
Diff: 3
Page Ref: 224
LO: 2
15.
Conventional investment funds rely heavily on interest-based debt to finance
their activities, therefore they may invest in:
( a
interest-bearing debt securities
b)
preferred stocks
c)
warrants
d)
all of the above
Diff: 1
Page Ref: 225
LO: 2
16. Because of the prohibition of riba, Islamic investment funds can invest
in the following income instruments such as:
a)
b)
c)
d)
corporate bonds
treasury bonds and bills
certificates of deposit (CDs)
none of the above
Diff: 3
Page Ref: 226
LO: 2
17. _____________for the Islamic funds entail that if an Islamic fund observes that a portion of its income comes from interest-related dealings, then the fund must dispose that portion of its income through charity in order to cleanse the fund earnings.
a)
separation
b)
integration
c)
purification
d)
screening
Diff: 2
Page Ref: 226
LO: 2
18. The practice wherein Sharī'ah boards permit the transaction of stocks while
benchmarks are occasionally breached up to a given approved level is called:
a)
short-term non-compliance with industry or financial screens
b)
temporary non-compliance with industry or financial
screens
c)
permanent non-compliance
with industry or financial screens
d)
none of the above
Diff: 3
Page Ref: 228
LO: 2
The certificate or document given to the subscribers that documents their rate
of ownership in the joint fund may be called
”a)
“shares
”b)
“units
"c)
"instruments
d)
all of the above
.19
Diff: 2
Page Ref: 229
LO: 3
20.
The major Islamic investment funds commonly used by Islamic funds
manager include:
a)
Islamic debt funds
b)
Islamic equity funds
c)
alternative investments
d)
all of the above
Diff: 2
Page Ref: 229-230
LO: 3
21.
Which one of the following funds is among the four major Islamic investment
funds commonly used by an Islamic funds manager?
a)
Islamic hedge funds
b)
c)
d)
special asset classes
mixed funds
public equity funds
Diff: 3
Page Ref: 229-230
LO: 3
22.
The structure of Islamic equity fund may be based on either:
a)
a mudarabah or musharakah contract
b)
a mudarabah or murabaha contract
c)
a musharakah or murabaha contract
d)
a mudarabah or musharakah or murabaha contract
Diff: 3
Page Ref: 233
LO: 3
23. The following are forms of funds under the alternative investments commonly practiced in the Islamic finance EXCEPT:
a)
private equity fund
b)
Islamic venture capital fund
c)
Islamic debt funds
d)
real estate funds or real estate investment trusts (REITs)
Diff: 2
Page Ref: 234
LO: 3
24. _____________are generally structured as private limited companies
with few large-capital individuals or institutional investors as stakeholders.
a)
private equities fund
b)
Islamic venture capital fund
c)
Islamic debt funds
d)
special asset classes
Diff: 2
Page Ref: 243
LO: 3
25.
Even though private equities are not exchange-traded and much of
their financial information is not disclosed, a Sharī'ah compliance audit
should still be put in place to:
a)
facilitate the disclosure of financial information
b)
guarantee the confidence of the investors
c)
ensure conformity with the principles of Al Sharī'ah
d)
protect the interests of stakeholders
Diff: 3
Page Ref: 234
LO: 3
26.
Both private equity fund and venture capital fund share the following
characteristic(s):
a)
they are not traded on exchanges
b)
they engage in long term investment positions in firms at different stages
c)
hold up the investment for a longer time horizon until they find
a suitable time to liquidate the investment
d)
all of the above
Diff: 2
Page Ref: 234
LO: 3
27.
Which one of the following procedures is used by venture capitalists to
liquidate their investments?
a)
initial public Offering
b)
company buyback
c)
trade sale
d)
all of the above
Diff: 1
Page Ref: 235
LO: 3
Which one of the following is not a procedure utilized by venture capitalists to
?liquidate their investments
a)
b)
c)
.d)
.28
write-off
secondary sale
auction sale
reorganization of the investee company
Diff: 2
Page Ref: 235
LO: 3
29.
____________ can be defined as the money and resources made available to startup firms and small business with exceptional growth potential.
a)
centure capital
b)
private equity
c)
real estate investment trusts
d)
hedge fund
Diff: 1
Page Ref: 234
LO: 3
The first step in analysing the feasibility of possible ventures is that Islamic
:venture fund
a)
conduct a project feasibility analysis similar to the conventional
venture capital fund
b)
test the soundness of the business plan
c)
perform Sharī'ah-compliance screening
d)
none of the above
Diff: 2
Page Ref: 236
LO: 3
31.
The Islamic venture capital fund draws its funds from a wide range of
sources such as:
a)
Islamic banks and financial institutions
b)
takaful companies
c)
individual investors who prefer the Islamic finance products
.30
d)
all of the above
Diff: 1
Page Ref: 236
LO: 3
32.
Which one of the following is not among the three conventional real estate investment trusts (REITs) broad categories as identified by Mohammed Obaidullah?
a)
Equity REIT
b)
Mortgage REITs
c)
Hybrid REITs
d)
none of the above
Diff: 1
Page Ref: 236-237
LO: 3
33.
Conventional REITs may be classified into the following three broader
categories based on their investment style and income generating
sources?
a)
1. Equity REITs
2. Private REITs
3. Hybrid REITs
b)
1. Equity REITs
2. Mortgage REITs 3. Hybrid REITs
c)
1. Equity REITs
2. Mortgage REITs
3. Private REITs
d)
1. Private REITs
2. Mortgage REITs
3. Hybrid REITs
Diff: 2
Page Ref: 236-237
LO: 3
Which one of the following funds is not amongst the three special asset classes
?that have been identified by modern Sharī'ah scholars
a)
Islamic hedge funds
b)
private equity funds
c)
funds of funds
d)
mixed funds
Diff: 1
Page Ref: 237
LO: 3
.34
35. _____________ is a passive strategy where the investing fund, instead
of creating an own portfolio, invests in another fund with a different investment objective to diversify its exposure.
a)
fund of funds investment strategy
b)
venture capital
c)
real estate investment trusts
d)
Islamic hedge funds
Diff: 2
Page Ref: 238
LO: 3
Some of the common business strategies (distributions and marketing) for
:Islamic investment funds include
a)
outsourcing
b)
reengineering
c)
diminishing musharakah
d)
all of the above
Diff: 1
Page Ref: 240
LO: 3
.36
37.
Which of the following is not a main challenge facing Islamic mutual
funds in terms of reaching out to their prospective investors?
a)
lack of liquidity
b)
the maturity and the integration of Islamic markets
c)
lack of appropriate management skills and the difficulties in
the outsourcing of proficient management
d)
the responsibility to create an educated investor base to ensure
customer loyalty
Diff: 1
Page Ref: 240
LO: 3
has been introduced to oversee all investment products, services and ___________ .38
contracts with a view to ensuring their compliance with the fundamentals of the
.Sharī’ah
a)
Islamic wealth management
b)
the Sharī'ah governance framework
c)
d)
Sharī'ah advisory board
quality assurance system
Diff: 2
Page Ref: 241
LO: 4
39.
Which of the following is not among the alternatives offered by the modern
practice of Islamic wealth management?
a)
to adopt the practices of the conventional finance industry
.b)
to employ the services of Sharī'ah consulting firms
c)
to employ the services of independent Sharī'ah scholars on an ad hoc
basis to ensure a full compliance with the requirements of the Sharī'ah
d)
b+c
Diff: 2
Page Ref: 241
LO: 4
40.
Ideally, the members of the Sharī'ah board should possess:
a)
a combination of strong academic and professional background
in Islamic jurisprudence
b)
a thorough understanding of the financial transactions and financial system
c)
a postgraduate degree either in Islamic finance or Islamic law
d)
A+B
Diff: 2
Page Ref: 242
LO: 4
The responsibilities of the Sharī'ah supervisory board may include all the following
:EXCEPT
a)
monitoring the fund’s compliance with the Sharī'ah;
b)
overseeing the fund’s portfolio purification;
c)
assisting the human resources department in the recruitment
process
d)
reporting on the compliance status of the fund;
Diff: 1
Page Ref: 242
LO: 4
42.
The most common financial instruments that are used in Sharī'ah-compliant
investment funds are:
a)
musharakah, istisna, mudarabah, al-qard al-hasan
.41
b)
musharakah, mudarabah, murabahah, and ijarah
c)
murabahah, bay bi thaman ajil, salam, mudarabah
d)
diminishing musharakah, ijarah, murabahah, sukuk
Diff: 1
Page Ref: 245
LO: 5
Islamic fund managers adopt the following main strategies to manage the
.market risks of their portfolios
a)
portfolio diversification and portfolio protection
b)
risk transfer
c)
applying strict monitoring measures
d)
all of the above
.43
Diff: 2
Page Ref: 246
LO: 5
Fund managers engage in the following strategies in order to minimize their risk
.exposures
a)
b)
c)
d)
SWAPs
options (call and put options)
futures Forwards
all of the above
Diff: 2
Page Ref: 246
LO: 5
45.
As there is no secondary market in conventional sense, fund managers may
have to depend on the following to exit an investment.
a)
b)
c)
d)
sponsor principal
nominated liquidity agent
asset management company
all of the above
Diff: 3
Page Ref: 247
LO: 5
Short Answer questions
Question 1
.44
Describe the mechanisms that Islam put in order for wealthy people to discharge
their social obligations toward the needy in society.
These mechanisms include zakat (compulsory alms), sadaqah (voluntary alms), waqf
(charitable endowment), and even takaful (Islamic cooperative insurance). The aim is
to foster community, economic empowerment, and the redistribution of resources.
Page Ref: 219
LO:1
Question 2
What are the basic considerations that must be account-for in applying the
Sharī'ah filter to the investment portfolios?
The fundamental considerations that must be considered in applying the Sharī'ah filter
to the investment portfolios are:
 The exclusion of all ribawi products, services, or investments
 Shares and stocks must be well screened to exclude all interest-bearing securities
 There is serious emphasis on ethical investment in Islam. All forms of deceitful dealings where one person earns multiple incomes at the expense of another are forbidden in Islam
 Fair trade and ethical dealing are encouraged in Islamic investing. Fund managers must respect the specific requirements of Muslim investors who prefer
Sharī'ah-compliant products
 The whole process must not contain any element of interest and this is where
religion plays a significant role in ethical investing .
Page Ref: 219
LO: 1
Question 3
Discuss the Islamic stand on the interest issue
Islam declares that all forms of interest, whether fixed or floating, simple or compound, are prohibited. ‘Nominal’ or ‘excessive’ interest amount to the same thing and
are treated alike under the prohibition rule. Regardless of whatever interest rate fixed,
even if it is as low as to 0.1 percent, it is still prohibited and must be totally excluded
from investment activities.
Financial returns on money must bear the two inseparable features of Islamic investing, i.e., profit and loss. Islamic investment funds involve the contribution of surpluses of investors to a joint pool for the purpose of investment in order to earn lawful
profits in accordance with the Sharī'ah.
Page Ref: 219
LO: 1
Question 4
Explain the concept of purification of income distribution
The implication of purification for Islamic funds is that if the fund observes some part
of its income is doubtful (i.e., through the use of credit or borrowed capital to increase
the earning potential of stock), then those earnings should be foregone. Islamic funds
should adopt proper financial screening as accurately as possible to figure out the
composition of doubtful earnings from the common stock of a firm. For example, if
an Islamic fund observes that 8 percent of its income comes from interest-related
dealings, then the fund must disburse that portion of its income through charity in order to purify the fund’s earnings.
Page Ref: 226
LO: 2
Question 5
Explain how Sharī'ah advisors classify the degree of non –compliance at any given time a firm may fall behind the benchmark requirement for Sharī'ah compliance
Shari‘ah advisors may classify the degree of non-compliance into any of the
following categories and accordingly describe the action to be taken by a fund manager.
 Temporary non-compliance with industry or financial screens. The Sharī'ah
board may permit the transaction of stocks while benchmarks are occasionally
breached up to a given approved level. However, the fund manager should report on the firm to the Sharī'ah board on a regular basis
 Short-term non-compliance with industry or financial screens. The fund manager should report to the supervisory board if a stock becomes non-compliant
for a longer period of time. The manager should also analyze the impact of returns from that firm on the overall return of the fund and set aside a certain
portion of earnings and donate it to an appropriate charitable cause. Usually,
the supervisory board reviews the status of these non-compliant stocks at regular intervals
 Permanent non-compliance. When a stock falls short of compliance benchmarks of Sharī'ah approvals permanently, the Sharī'ah board may ask the fund
manager to divest from such stocks.
Page Ref: 228
LO: 2
Question 6
Describe the stages in a company’s life cycle wherein venture capital investments
may take place
Venture capital investments may take place at any or a combination of different stages
in a company’s life cycle:
 seed-stage financing; when venture capitalists fund startup enterprises. This
usually involves the development of new business initiatives
 early-stage financing; which involves investing in companies that have received initial seed financing and have shown rapid growth potential
 formative-stage financing; another step further from early-stage financing. It
involves both seed-stage and early-stage financing, which support the initial
development of new products and scale up capabilities
 later-stage financing; which involves financing provided after product development, manufacturing of products, and sales with a marked increase in revenue growth, but before any initial public offering


expansion-stage financing; refers to the financing of the steps required to
make the initial public offering. The expansion stage is also known as the
mezzanine stage of financing, which naturally culminates in the initial public
offering
balanced-stage financing; which involves all the stages from seed-stage to expansion stage financing.
Page Ref: 234- 235
LO: 3
Question 7
Identify the procedures that venture capitalists usually utilize to liquidate their
investment.
After making their investments, venture capitalists usually hold the investment for a
relatively long time horizon until they find a suitable time to liquidate the investment
through any of the following procedures.
 initial public offering (IPO); a company’s flotation of tradable securities on a
stock exchange, where its shares are sold to public investors.
 company buyback; a company’s repurchase of its own outstanding shares.
This is either meant to reduce the number of shares in the market or reduce the
shareholding of a single investor
 trade sale; a common exit route for venture capital in its early stages where a
firm is sold to another company
 Write-off; a failure for the venture capitalist, when it believes it cannot recover
from its investment, although it may continue to hold shares in a non-viable
enterprise
 secondary sale; a sale of part or all of the investment of the venture capitalist
to another venture capitalist in a secondary sale without selling the shares of
the entrepreneur
 reorganization; a restructuring of the investee company, which may include recapitalization and total reorganization of the business to enhance profitability.
Page Ref: 235
LO: 3
Question 8
Explain briefly why investment in conventional investment funds has become much easier in terms of access and managing investment portfolios.
Investment in conventional investment funds has become much easier in terms
of access and managing investment portfolios for investors because:

conventional investment funds are taking advantage of their expansive marketing and distribution systems to ensure maximum exposure to their target
investor clients

conventional investment funds have re-structured their distribution networks
utilizing the web-based technology
 the easy access and availability of the conventional investment funds in
terms of liquidity.
Page Ref: 238
LO: 3
Question 9
Identify the different challenges that Islamic mutual funds face in terms of
reaching out to their prospective investors.
Islamic mutual funds face different challenges in terms of reaching out to their
prospective investors such as:
 Lack of liquidity
 Inadequate number of Sharī'ah compliant investment funds and investable securities
 Segmented and immature Islamic markets
 Lack of appropriate management skills and the difficulties in the outsourcing
of proficient management
 Uneducated customer base: Islamic funds need to provide their prospective
customers with proper education regarding the Islamic investment process and
its uniqueness in terms of risk features. Creating an educated investor base is a
crucial step to ensuring customer loyalty.
Page Ref: 240
LO: 4
Question 10
What are the functions of the Sharī'ah supervisory board?
The responsibility of the board may vary for different funds based on their charter and
may include, but not be limited to, the following functions:
• monitoring the fund’s compliance with the Sharī'ah
• overseeing the fund’s portfolio purification
• reporting on the fund’s compliance status
• assisting the fund’s management
• advising on zakat and identifying the procedures for its distribution.
Page Ref: 242
LO: 4
Question 11
What are the challenges faced by Islamic fund managers while trying to diversify
their investment portfolios?
The challenges for Islamic fund managers are twofold:
 First, they need to diversify their portfolios within a limited range of Sharī'ah
compliant asset classes
 Second, as the Islamic market has relatively lower depth in terms of trading
activity and lower breadth in terms of the number of asset classes traded, the
market may be more volatile compared to the conventional markets
Because of these inherent features, Islamic fund managers are more cautious
about managing market risks. An effective investment strategy for Islamic
fund managers is to diversify their portfolio in terms of industrial sectors or
geographical concentrations. Fund managers have to be skillful to identify as-
sets with negative or small correlations to ensure maximum benefit from such
diversification
Page Ref: 246
LO: 5