Considering the Annuity Formula: In Western countries a client who intend to buy a house apply for an annuity1 housing loan at their bank. After the pay-out of the debt amount the client pays a constant (annual) amount (interest and repayment of debt) to the bank for e.g. 25 years. The client is owner of the house and owes money to the bank, after 25 years (s)he is free of debt and still owns the house. Islamic law generally prohibits a charge of interest so that Islamic banks offer the following Islamic housing “loan contract” (called “Islamic loan”): 1. The house is bought by the bank in t = 0 so that she is owner of the house. 2. The client pays a periodic rent to the bank for a defined period of 25 years. 3. After 25 years the bank donates the house to the client (“for free”) if the rent was regularly paid (without any outstanding payments). Question 1: Please specify all possible parameters (i.e. variables) on an Islamic loan contract so that an Islamic bank can calculate the conditions of this contract. Question 2: Please briefly argue how you would “derive” the missing variable of the annuity formula for the Islamic loan. Question 3: Please duplicate the Islamic loan by “Western” financial instruments. Please note your view (either bank’s or house renter’s view).
Considering the
In Western countries a client who intend to buy a house apply for an annuity1 housing loan at
their bank. After the pay-out of the debt amount the client pays a constant (annual) amount
(interest and repayment of debt) to the bank for e.g. 25 years. The client is owner of the
house and owes money to the bank, after 25 years (s)he is free of debt and still owns the
house.
Islamic law generally prohibits a charge of interest so that Islamic banks offer the following
Islamic housing “loan contract” (called “Islamic loan”):
1. The house is bought by the bank in t = 0 so that she is owner of the house.
2. The client pays a periodic rent to the bank for a defined period of 25 years.
3. After 25 years the bank donates the house to the client (“for free”) if the rent was
regularly paid (without any outstanding payments).
Question 1: Please specify all possible parameters (i.e. variables) on an Islamic loan contract so that
an Islamic bank can calculate the conditions of this contract.
Question 2: Please briefly argue how you would “derive” the missing variable of the annuity formula
for the Islamic loan.
Question 3: Please duplicate the Islamic loan by “Western” financial instruments.
Please note your view (either bank’s or house renter’s view).
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