islamic wealth management - 07-07-2013

7/27/2019 Islamic Wealth Management - 07-07-2013

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Introduction to: Risk & return. Risky and risk free investments. Indirect investments & direct investments Marketable & non- marketable securities. Capital & money market securities.


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Often defined as the standard deviation of the return on

total investment or degree of uncertainty of return on anasset or the possibility that the actual return on aninvestment will be different from its expected return.

As defined by SBP

For the purpose of these guidelines financial risk in abanking organization is possibility that the outcome of anaction or event could bring up adverse impacts. Such

outcomes could either result in a direct loss of earnings /capital or may result in imposition of constraints onbanks ability to meet its business objectives.


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Risks are usually defined by the adverse impact on

profitability of several distinct sources of uncertainty.While the types and degree of risks an organization maybe exposed to depend upon a number of factors such asits size, complexity business activities, volume etc, it is

believed that generally the banks face Credit, Market,Liquidity, Operational, Compliance / legal / regulatoryand reputation risks.

(BSD Circular 07 of 2003)


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returns. Stocks are riskier; they offer no guarantee andthus can yield higher returns. After all, the government isunlikely to go out of business, whereas many companiesfail every day. In the end, investors should expect to berewarded for taking on additional risk.

Three different levels of potential risk:1. The maximum return offered by an investment may

not be materialized.

2. The investor get only a very low or no return at all.

3. The investor may even lose some or all of his capital.


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The concept of risk free investment where the capital andthe return is guaranteed means that returns are low asthe product provider is actually charging a fee for theguarantee. In this respect the wealth manager needs tolook at other product providers for similar products. Onthe other hand, under a high risk product, the productprovider has a special investment vehicle which theybelieve will produce a very high returnprovided itworks. Since the product provider strongly believes thatthe vehicle will produce very high returns and since theyneed capital to make it work, they are willing to give theinvesting client a higher return. Investing clients usuallyare willing to participate in such investments if theythink that the risks are lower then the return.


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The trade-off in Islam has another dimension: it is between thisworld and the hereafter. In Islam, one must always give

performance to the hereafter unlike the risk-return where one has achoice whether to take a higher risk in exchange for a higherexpected return. The concept is explained in the Quranic verse:

therefore those who sell the life of this world for the hereafter should

fight in the way of Allah. Whose fights in the way of Allah, be heslain or be he victorious, on him We shall bestow a vast reward(Quran 4:47).

The verse explains that the returns (vast reward) definitely

obliterates the risks (be slain). In another verse, the Quran says:Such are those who by the life of the world at the price of theHereafter. Their punishment will not be lightened, neither will theybehave support (Quran 2:86)


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The theoretical rate of return for an investment that haszero risk. The risk-free rate represents the expected return

from an absolutely risk-free investment over a specifiedperiod.

It is an investment where the return is known with

certainty. The certainty generally comes from a supremeamount of confidence in the issuer of the investment; forexample, Treasury securities are considered risklessinvestments because the Government is considered the best

possible issuer. Critics contend that there is no such thingas a riskless investment because, in theory, even theGovernment could default. However, riskless investmentshave such a low level of risk that it may be ignored.


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Direct Investments Defined

The purchase of a controlling interest in a company or atleast enough interest to have enough influence to directthe course of the company.

It means an Investment that is made to acquire a lastinginterest in an enterprise operating in an economy otherthan that of the investor, the investors purpose being tohave an effective voice in the management of theenterprise." In practice, this translates to an equityholding of 10% or more in the foreign firm.

(International Monetary Fund)


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A security that may not be easily bought or sold.

Generally, a nonnegotiable security may be redeemedby the issuer, but this is often subject to somelimitations. Low-risk instruments such as savingsbonds and certificates of deposit are examples ofnonnegotiable securities. They are also callednonnegotiable or nontradeable securities.

These type of security does not trade on a normalmarket or exchange instead they are traded over the

counter (OTC) or in a private transaction. Finding aparty with which to transact business is oftendifficult. In some cases, these securities can't beresold due to regulations surrounding the security.


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A financial market for trading short-term, low-risksecurities such as commercial paper, bonds, certificates of

deposit etc. The market is made up of dealers in thesesecurities who are linked by electronic communications.

Network of banks, discount houses, institutionalinvestors and money dealers who borrow and lend

among themselves for the short term. Money market alsotrade in highly liquid financial instruments suchcertificates of deposit, commercial papers andgovernment securities such as treasury bills, sukuk

bonds. Money markets are largely unregulated andinformal where most transactions are conducted overphone, fax, or online.


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islamic wealth management - 07-07-2013

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