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June 24, 2004

SEMINAR ON DERIVATIVES IN ISLAMIC FINANCE “ISLAMIC PROFIT RATE SWAP – Perspective from Conventional IRS” by Chu Kok Wei. June 24, 2004. Coverage . Conventional IRS mechanics Terms of an IRS MYR Conventional IRS Market Quotation & Conventions Islamic Profit Rate Swap

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June 24, 2004

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  1. SEMINAR ON DERIVATIVES IN ISLAMIC FINANCE“ISLAMIC PROFIT RATE SWAP –Perspective from Conventional IRS”byChu Kok Wei June 24, 2004

  2. Coverage • Conventional IRS mechanics • Terms of an IRS • MYR Conventional IRS Market Quotation & Conventions • Islamic Profit Rate Swap • Equivalent Terms of an IPRS • Proposed Market Quotation and Conventions • Documentation • Comparison Between IRS and IPRS • Netting Issues • Early Termination

  3. Conventional Interest Rate Swaps • Terms of an Interest Rate Swap • Trade Date • Effective Date / Start Date • Maturity Date / End Date • Frequency ( Monthly, Quarterly, S/A, etc) • Reference Index (3M KLIBOR, 6M KLIBOR, etc) • Fixing Lag • Day Count Convention (ACT/365, ACT/360, 30/360, etc) • Business Day Convention (Following, Mod Following, Unadjusted, etc) • Holiday Table

  4. Conventional Interest Rate Swaps • MYR Market Convention & Quotation Method • Quotation Method : Offer / Bid quotation • Effective Date : Same Day as Trade Date • Maturity Date : x-Year from the Effective Date • Frequency : Quarterly • Reference Index : 3-Month KLIBOR (page <KLIBOR> on Reuters) • Fixing Lag : 0 day (same day fixing) • Day Count : ACT/365F both fixed and floating leg • Business Day : Modified Following Business Day Convention • Holiday Table : Kuala Lumpur

  5. MYR Islamic Fixed Rate Bonds • Profit Rate Bearing Islamic Private Debt Securities (PDS) • Profit Rate is fixed up-front at point of issuance • Convention is Semi Annual profit rate payment frequency • Calculation is ACT/ACT semi annual on half of the profit rate • Example • 6.00% Profit Rate PDS, issued on 24 June 2005 maturing 24 June 2010. • Profit rate dates are 24 June and 24 December • Each profit rate amount is 3.00% of face value, fixed • Inter- profit rate dates accrued interest calculated on ACT/ACT basis • No adjustment to profit rate amount even on holidays

  6. IPRS Proposed Convention • Fixed Leg • In order to provide better hedging to the MYR Islamic fixed income securities, it is desirable that the Fixed leg of IPRS matches the calculation convention of Islamic fixed income securities. • Frequency : Semi Annual • Day Count : Actual / Actual • Business Day : Following / Preceding (depends on fixed income) • Current Leg (Floating leg) • Frequency : Quarterly or S/A (credit consideration if mismatch) • Day Count : Act/365F (to follow funding calculation) • Business Day : same as fixed leg to reduce mismatch credit risk • Current Rate : KLIBOR ( page <KLIBOR> on Reuters) • Fixing Lag : 0 day, same day fixing

  7. Conventional Interest Rate Swap ISDA Master Agreement Trade Confirmation Payment Advice Transaction Netting is practiced to net off payment between fixed and floating leg Islamic Profit Rate Swap Islamic Swap Master Agreement Trade Confirmation 2 sets of Asset Purchase and Asset Sale Agreements Transaction Netting is allowed to net off payments between the 4 asset purchase and asset sale agreements to arrive at net payment. Documentation Comparison

  8. Early Termination • Possible Reasons • Trigger of Early Termination events • Mutual Termination Clause • Mutual agreement to terminate transaction • Other illegality reasons • Spirit of Settlement • The party who is “out-of-money” should settle the amount owed to the party who is “in-the-money”. • Calculation method - Market Quotation Method / Loss Method • Cash Settlement Method

  9. Early Termination Principle - IPRS • As the IPRS transaction is settled via 2 sets of asset purchase and asset sales agreement (one for fixed leg, and one for current leg), any early termination would render future agreements non-applicable. • Since future asset purchase / asset sale agreement are not performed, is there any loss ? Hence any marked to market settlement ? • The commitment to enter into future asset purchase and asset sale agreement is evidenced in the Trade Confirmation Agreement, which is legally binding and obliging. • Settlement Amount is seen as the payment to be exchange for the release of obligation to continue to perform the committed future asset purchase and asset sale agreement.

  10. Early Termination Principle - IPRS • Calculation Method • Similar to conventional IRS fair valuation • Present value of all future cash flows (fixed leg) and projected cash flows (floating leg) • The amount of NPV is set as the settlement amount for both party to be released from future obligations of the IPRS as agreed in the Trade Confirmation Agreement. • Settlement Amount • As agreed between the 2 counterparties • Market Quotation method from panel of Cash Settlement Reference Banks

  11. Contact Details CIMB Islamic Commerce International Merchant Bankers Berhad 10th Floor, Bangunan CIMB Jalan Semantan, Damansara Heights 50490 Kuala Lumpur, MALAYSIA Tel : +603 2084 8888/+603 2084 9666 Fax : +603 2093 0685 www.cimb.com.my

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