Arabic (مبادلة الربح) for profit rate swap. By definition, it is an Islamic swap that entails the exchange of a floating profit rate for a fixed profit rate, or vice versa. For example, party A contemplates issuing a one million BD (Bahraini dinar) sukuk with a one-year tenor (say, 1 August 2015). Sukuk pay out a capital (principal) amount at one-year maturity and monthly floating amounts to investors (sukuk holders) over the course of its tenor. A variable benchmark (one-month LIBOR or its equivalent) is used to figure out the periodic floating amount payable to sukuk holders. Party A is exposed to changes in that benchmark rate. As such, the sukuk are linked to one-month LIBOR, so the 12-month sukuk have twelve one-month calculation periods starting on 1 August. Party A seeks to protect itself against the possibility that the benchmark rate on which the periodic floating amounts are based will increase. By entering into mubadalat al-ribh, party A can fix its exposure resulting from the sukuk. Party B could be an Islamic bank with a large fixed profit rate holdings/portfolio and, for risk management purposes, it wishes to hedge itself by converting some of its fixed profit rate exposure into floating profit rate exposure.
Mubadalat al-ribh helps party A to hedge its floating profit rate exposure under the sukuk by converting it into a fixed profit rate exposure (i.e., party A is aware that by paying the fixed amounts to party B, party A will receive from party B the floating amounts required to make payment under the sukuk agreement). Party B’s income was mainly floating income and through mubadalat al-ribh it would be able to convert some of that income into stable fixed income.
