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Assessing the application of Islamic and conventional hedgings in Indonesia

Assessing the application of Islamic and conventional hedgings in Indonesia Banks in Indonesia offer two currency-hedging mechanisms to business players to hedge their portfolio against exchange rate risk, namely, Islamic hedging and conventional hedging. Taking into account that Islamic finance stakeholders in Indonesia want to accelerate Islamic hedging transactions, assessing the feasibility of Islamic hedging to serve the business players is very important. Thus, this paper aims to compare the conventional and Islamic currency-hedging mechanisms, particularly to identify which one to be preferred by the business players, identify terms and conditions if Islamic hedging is more preferable, give information regarding the estimated profit and payment of the premium in adopting currency-hedging (both conventional and Islamic hedgings) and prove the workability of Islamic currency-hedging as a new hedging mechanism for the business players.Design/methodology/approachThe paper uses qualitative research methodology by comparing Islamic and conventional hedging and a quantitative research method by using a forward contract formula. Technically, the paper conducts a static simulation of the forward transactions by using both conventional and Islamic hedgings to hedge the foreign exchange (forex) credit received by business players from banks. The forward contract simulation uses US dollar (USD) against Indonesian rupiah (IDR) from December 2003 to February 2019 and the forward premium uses both Islamic and conventional money market rates called PUAB (conventional interbank money market) rate and PUAS (Islamic interbank money market) rate.FindingsThe paper finds that Islamic hedging is more preferable to conventional one due to some considerations which are the number of profitable months, the minimum payment of premium and the highest payment of profit. However, even though the Islamic hedging mechanism has the advantage of having a higher Islamic money market rate than the conventional one, the economic condition (particularly the movement of IDR exchange rate) has to be considered as well particularly during the volatile exchange rate movement.Research limitations/implicationsThe paper has not occupied macroeconomic variables such as inflation, GDP, international trade, as they might influence the movement of IDR exchange rate. In addition, it uses static simulation rather than a dynamic one.Originality/valueThis is the first paper assessing both Islamic and conventional hedging mechanisms in the case of Indonesia http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png International Journal of Islamic and Middle Eastern Finance and Management Emerald Publishing

Assessing the application of Islamic and conventional hedgings in Indonesia

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References (25)

Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1753-8394
DOI
10.1108/imefm-06-2020-0300
Publisher site
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Abstract

Banks in Indonesia offer two currency-hedging mechanisms to business players to hedge their portfolio against exchange rate risk, namely, Islamic hedging and conventional hedging. Taking into account that Islamic finance stakeholders in Indonesia want to accelerate Islamic hedging transactions, assessing the feasibility of Islamic hedging to serve the business players is very important. Thus, this paper aims to compare the conventional and Islamic currency-hedging mechanisms, particularly to identify which one to be preferred by the business players, identify terms and conditions if Islamic hedging is more preferable, give information regarding the estimated profit and payment of the premium in adopting currency-hedging (both conventional and Islamic hedgings) and prove the workability of Islamic currency-hedging as a new hedging mechanism for the business players.Design/methodology/approachThe paper uses qualitative research methodology by comparing Islamic and conventional hedging and a quantitative research method by using a forward contract formula. Technically, the paper conducts a static simulation of the forward transactions by using both conventional and Islamic hedgings to hedge the foreign exchange (forex) credit received by business players from banks. The forward contract simulation uses US dollar (USD) against Indonesian rupiah (IDR) from December 2003 to February 2019 and the forward premium uses both Islamic and conventional money market rates called PUAB (conventional interbank money market) rate and PUAS (Islamic interbank money market) rate.FindingsThe paper finds that Islamic hedging is more preferable to conventional one due to some considerations which are the number of profitable months, the minimum payment of premium and the highest payment of profit. However, even though the Islamic hedging mechanism has the advantage of having a higher Islamic money market rate than the conventional one, the economic condition (particularly the movement of IDR exchange rate) has to be considered as well particularly during the volatile exchange rate movement.Research limitations/implicationsThe paper has not occupied macroeconomic variables such as inflation, GDP, international trade, as they might influence the movement of IDR exchange rate. In addition, it uses static simulation rather than a dynamic one.Originality/valueThis is the first paper assessing both Islamic and conventional hedging mechanisms in the case of Indonesia

Journal

International Journal of Islamic and Middle Eastern Finance and Management – Emerald Publishing

Published: Jan 18, 2022

Keywords: Profit; Islamic hedging; Rupiah; G11; G14

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