Hedging Instruments in Conventional and Islamic Finance

Abstract

The paper presents instruments of hedging and risk management applied in both conventional and Islamic banking market places. We compare the framework, modes and instruments of financing in these two banking environments and explore the speculative behavior of Islamic Banking. In this research, we refer to information from different papers, proceedings and websites to identify distinguishing aspects of these two banking systems and the related risk mitigation (hedging) instruments. We show that hedging for risk management in these two banking systems are actually quite similar, although the concept, framework, goals and objectives, as well as risks, are different in their respective business activities. Using available information it also presents a simulated normal model of Islamic Cross-Currency Swap in relation with that of conventional swap market. Further investigation is needed to identify why Islamic banks replicate the conventional banking hedging instruments and how the Islamic hedging instruments are effectively based on double rules and regulations such as Shariah and Local Government, as well as four-fold tax obligations (Zakat and Government Tax).