Marketable profit-and-loss sharing contracts : broadening the global non-equity capital markets

Abstract

In this paper we have provided the theoretical foundation for a “profit-and-loss sharing contract” as a practicable alternative to corporate bonds. We mathematically demonstrate that the standard pricing model for a straight coupon bond is obtainable as a special case of a profit-and-loss sharing contract valuation model. We also show that the returns to the holder of a profit-and-loss contract, even in the presence of market friction, can be potentially greater than those from a straight corporate bond if there is a substantial default risk premium. Our analysis provides a means of broadening the global market for non-equity capital by offering an alternative to interest-bearing debt which is not socio-religiously acceptable in some cultures and can be of special relevance, for example, to many emerging markets in Asia and Middle East</jats:p