DESIGN AND PRICING OF ASSET BACKED SUKUKS STRIP SECURITIES: AN ENDEAVOUR TOWARDS FINANCIAL DEEPENING AND DEVELOPMENT

Abstract

The efficiency of Islamic Financial Industry, suffers due to lack of liquidity management instruments, and shallow secondary market activity. This paper reviews the financial intermediation theory and the complementary role of debt and money markets, towards the broader goal of allocative efficiency, asset transformation, diversification and welfare of all economic agents. Separately Tradable Registered Interest and Principle (STRIPs), created by disintegrating coupon and principle payment to be traded as discrete discount bonds, have been effectively employed in the west for liquidity management. This paper proposes a novel idea of Sukuk STRIPS that splits the payoffs Ijarah Sukuk in to a bunch of zero coupon bonds based on the leasing rental and the terminal / liquidation payoffs. It further expands on the design of STRIPS, and present a pricing model by employing lease valuation, certainty equivalent and bootstrapping. Instead of the prevalent capital asset pricing model based valuation, the volatility of the payoff of an Ijarah sukuk has been modelled by employing certainty equivalent approach (Zhang, 2010), which extend the term of analysis to a micro-level investor utility function. The viability of the design is further substantiated by numerical illustrations. The Ijarah Sukuk STRIPS proposed, would not only serve as a short term liquidity management instruments, but also develop a complete yield curve, facilitate price discovery and define the term structure of profit rates of Islamic debt markets. In case of sovereign issues, these STRIPs would enable efficient monetary transmission as well fiscal management for the underdeveloped Muslim world.