Islamic Vs Modern Bond

Islamic vs. Modern

Bond Market

PROF. DR. MOHD. MA’SUM BILLAH

(e-mail: masum2001@yahoo.com)

INTRODUCTION

A bond is a "security" which gives the holder a financial claim on the issuer. This claim protects the holder in circumstances in which the issuer is unable to pay the amount due. Bonds bear certain similarities to savings accounts. When an investor deposits money in a savings account, in effect, that investor is lending the bank money. The bank pays the investor interest on the deposit. Similarly, the investor who buys bonds lends the issuer money in return for interest payments. When the bonds mature (come due), the investor will receive the principle amount of the bonds back, as he would have if he had withdrawn the amount from the savings account. The major difference between savings accounts and bonds is that investors can sell their bonds before they mature to other investors. Savings accounts cannot be sold to other investors.

The legal documentation for a bond is required to specify the terms for both interest and principal payments. Interest can be paid monthly, semi-annually or annually. This makes a difference to the compounding of the interest and will affect the trading of a bond. Most bonds are pay interest semi-annually in North America. "Eurobonds", which trade in Europe, pay interest annually. Mortgage-Backed Securities (MBS) and Asset-Backed Securities (ABS) are pay interest monthly, reflecting the payment terms of the underlying mortgages and loans. The currency of payments is important. Some bonds have the coupon paid in one currency and the principal in another. Bonds which pay part of their principal before maturity are said to "amortize" their principal, this is the case with many mortgage bonds.

Bond market comprises of primary market and secondary market. The primary bond market is where the bonds are initially issued, while the secondary market where the bonds are resold to other investors. Islamic bonds are also having primary and secondary markets. The main difference, however, is the way the bonds are issued and traded afterwards. In the process of Islamic bond issuance bay’ al-‘Inah is used to securitize the instrument in the primary market, while in the secondary market, bay’ al-Dain is used in order to legalize reselling of the bonds. Such process is mostly used in the Malaysian market, while most of the Middle-Eastern countries do not accept it. The proposed alternative is Islamic bonds based on Muqaradah.

CONVENTIONAL BOND MARKET

Primary market: A financial market in which new issues of a security, such as a bond or a stock, are sold to