Summary
Islamic finance is achieving a household stature in the world of financial management. Although Islamic finance borrows financial principles from conventional systems, there are differences between the two (Afshar, 2013). In this regard, comparing the Islamic bonds referred to as Sukuk and conventional bonds is tantamount. This paper compares and contrasts Sukuk and conventional bonds.
Definitions
Conventional bonds are long-term debts mainly utilized by governments and corporations. In this regard, conventional bonds are used as investment instruments that generate two types of cash flows (Afshar, 2013). For example, bondholders receive a fixed amount of money referred to as face value. However, this occurs after the bond has matured over time. On the other hand, the bond issuer is obligated to pay a predetermined interest either annually or semi-annually (Afshar, 2013). However, both the maturity date and interest which is also the coupon are fixed. The bond issuer understands the obligation of delivering the cash flows irrespective of whether profit or loss was incurred after the issuance of bonds.
Sukuk is referred to as certificates of joint ownership representing equal value in regard to assets or future monetary value from the same within a determined time (Obaidullah, 2005). However, risks associated with the monetary value generated from Sukuk pass to holders of the same (Afshar, 2013).
Characteristics
As indicated earlier, Sukuk is a certificate representing a claim of ownership and cash flow. On the other hand, conventional bonds represent a claim on debt (Afshar, 2013). Precisely, this means conventional bonds are securities in the form of a loan to be paid on a predetermined date of maturity. Therefore, as a debt, interest is paid at a fixed rate along with the loan.
The returns on Sukuk are determined from the acquired assets. On the other hand, returns on the conventional bond are predetermined using a fixed interest rate. In this context, Sukuk provides income as evidenced in conventional bonds. However, Sukuk investors have a chance to gain from capital appreciation compared to conventional bonds (Ariff & Safari, 2012). Precisely, Sukuk investors engage in a seller-buyer contract which is contrary to the borrower-lender relationship evidenced in conventional bonds investments. Therefore, Sukuk involves the selling of assets based on their net, market and fair value. In this context, the return on invested capital is not guaranteed when dealing in Sukuk. In addition, Sukuk generates a fixed or variable rate of returns compared to a fixed return in conventional bonds. A similar characteristic between Sukuk and conventional bonds is that assets or services dealt with are tangible or intangible, and existing or described.
Risk exposures
Conventional bonds are susceptible to financial risks. In this context, the bond issuer defaults on paying the interest or face value. The financial risk can also happen in the case of Sukuk. However, conventional bondholders engage the bond issuer in the lawsuit as a remedy in case of default (Tariq & Dar, 2007). On the other hand, Sukuk holders’ recourse is to repossess and assume ownership of the asset in question.
Conventional bondholders are vulnerable to call risk. In this regard, the bondholder has an obligation to resell a bond to the issuer in case a huge market interest emerges (Tariq & Dar, 2007). On the other hand, Sukuk holders do not experience the negative impact of the fluctuating market interest rates.
Liquidity risk occurs when it becomes difficult to sell a bond. Precisely, this happens when the secondary market does not exist to support a reasonable price at the required time. Both conventional bonds and Sukuk are susceptible to liquidity risk.
Purchasing power risk affects both conventional bonds and Sukuk in different ways. For example, conventional bond yields are low during the season of the high inflation rate. On the other hand, Sukuk yields increase under a high inflation rate. However, foreign exchange risk affects both conventional bonds and Sukuk in a similar manner (Jobst, Kunzel, Mills & Sy, 2008). Moreover, there are risks that predominantly affect Sukuk and not conventional bonds. For example, a risk emanates when a violation of Sharia law is evidenced in a Sukuk case. A price risk also affects Sukuk al-ijara when the value of the asset changes before the maturity date due to depreciation or damage (Obaidullah, 2005). Sukuk is also affected by legal risks resulting from conflicts between Sharia law and a country’s general regulations.
Fig 1.0. A comparison of conventional bonds and Islamic Sukuk.
References
Afshar, A. T. (2013). Compare and contrast Sukuk (Islamic bonds) with conventional bonds, are they compatible? The Journal of Global Business Management 9(1), 44-52.
Ariff, M. & Safari, M. (2012). Are Sukuk securities the same as conventional bonds? Afro Eurasian Studies 1(1), 101-125.
Jobst, A., Kunzel, P., Mills, P. & Sy, A. (2008). Islamic bond issuance: what sovereign debt managers need to know. International Journal of Islamic and Middle Eastern Finance and Management, 1(4), 330-344.
Obaidullah, M. (2005). Islamic financial services. PDF File.
Tariq, A. A. & Dar, H. (2007). Risks of Sukuk structures: Implications for resource mobilization. Thunderbird International Business Review, 49(2), 203-223.