Efficient computation of Islamic yield and forward rates in sukuk market of Malaysia

Abstract

The dynamic yield rates prevailing in the bond market determines the bond portfolio values as the yield rate is negatively correlated with the bond value. Due to economic conditions principal in the country the yield rate sometimes goes up which cause the bond portfolio values to go down. This value loss is to be contained by risk management, which requires accurate yield and forward rates. The future yield rates are determined by term structure methods and published for almost 30 years. The English published are not at regular intervals. They have a lot of gaps this gap stops to be filled to get yield rates at regular intervals of every six months. The interpolation technique and spline methods were applied to get the missing yield rates. These methods produce larger errors which cause miscalculation of expected losses, defeating the objective of risk management. In this article to overcome this problem, we apply Nelson Siegel Svensson (NSS) method to compute the missing yield rates by minimizing the errors through non-linear optimization. We take the sukuk yield rates provided by the Bank Negara Malaysia and apply Microsoft Excel salver function and compute all yield rates once in every six months. These computed NSS regular yield rates are applied to get forward rates. These forward rates are essential to compute value at risk accurately. Once the value at risk is quantified accurately it is easier to hedge the portfolio value so as to avoid the value at risk. We prove that forward rate computed for 2021 and 2022 are converging well with the yield rates given by Bank Negara. The method we explain will be useful for asset managers and also the portfolio risk managers.