Academic journal article Asian Social Science

The Concept of Hedging in Islamic Financial Transactions

Academic journal article Asian Social Science

The Concept of Hedging in Islamic Financial Transactions

Article excerpt

Abstract

Hedging is a method to safeguard or minimize loss from risk that constantly exists in the financial market. Nevertheless, hedging in conventional perspectives involves the usage of derivative instruments which are controversy in Islamic view. Thus, the noble purpose of hedging that is to manage risk has been misunderstood as only to gain profit. The concept of hedging needs a further discussion because of its various interpretations on the meaning of hedging. Hence, the aim of this study is to discuss the general concept of hedging and subsequently the concept of hedging according to Islam. The approach used in this study of content analysis is the qualitative research method of document analysis. The researcher highlights the literature materials such as academic books relating to hedging including contemporary and classic fiqh scriptures. The study finds that the concept of hedging according to Islam is different from the conventional concept of hedging. This means, the study has developed a new theory of Islamic hedging. The theory of Islamic hedging must be based on the hadith of al-kharaj bi al-daman and fiqh maxim of al-ghunm bi al-ghurm approaches. In addition, the objective of Islamic hedging to reduce risk must only be related to real economic activities.

Keywords: hedging, risk management, speculation, shariah

1. Introduction

International trades do not run effectively without foreign currency exchange transactions. However, fluctuations of foreign currency rates can affect losses as well as gains to those involved. Thus, the ability to exchange currencies at a lower cost is a major prerequisite in making sure such trading optimise gains. Indeed, the ability to reduce exposure of foreign currency exchange risks is also vital in the view that international trades normally take time in payments and invoice submission.

Muslims involvement in the international trade resulting in the essential requirement of foreign exchange trade in the context of Muslim world. Among the parties who are directly involved in foreign currency exchange transactions are the central bank, commercial banks, corporate firms, brokers and savings funds. Hence, hedging is necessary for that purpose (Obiyathulla, 2000). With hedging activities, concerns over future price movements facing the investors, importers and exporters will be reduced.

There are varying views of hedging concept. Some suggest hedging as an activity of buying insurance policy to cover loss from unwanted risks. (Toporowski, 2000; Clark & Gosh, 2004; Kolb & Overdahl, 2006). Apart from that, hedging is also defined as a consolidation of profiteering objective and to risk aversion. Profit is important in hedging operations in the sense that the profits made will offset against any future price fluctuations (Abu Bakar, 2010). Even though the main objective of hedging concept is to reduce the risk of loss, the questions arise whether the concept of hedging can be used to avoid risks (Elgari, 2010), eliminate risks (Abu Bakar, 2010), or gains (Rosalan, 1993), or perhaps simply to reduce risks alone (al-Suwailem, 2006)? This shows that the understanding of hedging concept in accordance to syariah perspective is still being shrouded with confusions.

In Arabic, the definition hedge is known as tawaqa, tahawwut, hiyatah, ihtima' or taghtiyyah which means protection. The word hiyatah according to the language is precaution, protection and attention (Ibn Manzur, 2002). Al-tahawwut on the other hand originally meant the years of drought. It is also associated to something that enshrouds mankind and can destroy them (al-Zabidi, t.th.) In other words, tahawwut means enshrouding because droughts have always been engulfing mankind and surrounded them in troubles. Meanwhile, according to Elgari (2010), tahawwut technically is a strategy devised to eliminate risks.

Hedging is also an effort to ensure that the risk or possible losses can be reduced when a person makes a commitment in a liquidity market. …

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