The Islamic profit rate swap allows two parties to exchange a series of profit payments in a single currency in exchange for another series of payments in the same currency. For example, it allows for the exchange of profit rate cash flows between a fixed rate party and a floating rate party or vice versa implemented through the execution of a series of underlying contracts to trade certain assets under the Shariah principles of Murabahah, Bai Bithaman Ajil (BBA), Mudharabah, Bai –el-inah and many others

The profit rate cash flows are calculated on a notional principal amount, at specified intervals (payment dates) during the life of the agreement. Although there are no standardized swaps, a plain vanilla swap typically refers to a generic IPRS in which one party pays a fixed rate and the other party pays a floating rate (usually Klibor or Libor or any other indexes)

Profit rate swap is a mechanism structured to allow bilateral exchange of profit streams using two parallel and back to-back Islamic marked-up sale transactions (Murabahah)

IPRS can be structured based on the following Shariah principles

1. Murabahah

   A sale of commodity at the price the seller has purchased it, with the addition of a stated profit known to both the seller and buyer. It is a cost-plus profit sale in which the seller expressly discloses the profit

2. Bai Bithaman Ajil

   BBA is a sale contract in which the payment of the price, a cost-plus profit, is deferred and payable at a certain particular time in the future

3. Bai-el-Inah

   Sale of a commodity on credit and repurchasing it for a lesser amount in cash. It is accepted by Shafie’s Teaching and confined within Malaysia

4. Al-Wa’ad

   According to Islamic law, Al-Wa’ad means promise. It is a promise which connotes an expression of willingness of a person or a group of persons on a particular subject matter. In this case the promise is to purchase commodity at a certain particular time in the future, at a specific price

The minimum amount for IPRS transaction is RM5mil and the maximum amount is subject to the counterparty/ client’s limit

Islamic Profit Rate Swap contract/transaction period can range from a minimum period of minimum 6 months and no maximum tenors depending on requirements and market availability

Features

IPRS is a basic derivative product traded over the counter (OTC) where 2 parties agree to exchange future periodic profit cash flows based on predetermined notional amount. Both counterparties should have signed a standard Master Agreement before concluding any deal

Settlement depends on the structure of the swap. normally is on quarterly basis. If the settlement falls on a holiday, the settlement will be carried forward to the next working day

Net profit is settled between 2 counterparties where if:

• The fixed rate is higher than the floating rate; the fixed rate receiver (offerer) will be receiving net of the fixed rate minus the floating rate
• The fixed rate is lower than the floating rate, the fixed rate receiver (offerer) will be paying net of the floating rate minus the fixed rate
• Day count : Actual / 365

Formula :
(Fixed rate – Floating rate)/100* (Actual days in the quarter/365) * Notional Amount