Sukuk with Index-linked Coupons and Hedging: Case Study of Petronas

Abstract

A sukuk (an Islamic debt instrument) is reasoned to be equivalent to an index-linked coupon bond that pays coupons with values that are stochastic — depending on a market defined index — has been proposed in Belal Ehsan Baaquie (2018a), Belal Ehsan Baaquie (2020). Oil is one of the most important commodities. The proposed model is studied by taking the index of the coupons to be based on the price of oil, given by Brent Crude Oil Index or WTI (West Texas Intermediate). In particular, a case study is carried out in which fixed coupon bonds issued Petronas are compared with a corresponding sukuk with index-linked coupons. A novel hedging procedure for the index-lined sukuk (coupon bond) can be defined using the underlying commodity on which the index is based: when the sukuk is issued a fixed quantum of the commodity can be allocated and ring-fenced for paying the coupons of the sukuk; the sale of this commodity provides the tangible asset that generates the revenue required for the future payments of the index-linked coupons for a wide variation of the index.