A Sukuk is the islamic world’s version of a bond. It is also referred to as an islamic bond. Because Islamic people do not believe in charging or paying interest, they have been forced to maneuver their way around interest by renting certain assets or by taking ownership in a project.
A Sukuk structure is slightly different, but the principle is the same as a western bond. When a bank invests in a Sukuk or islamic bond, it is considered to be an investment in a certain project or asset that a company is working on. As the project or asset is complete or purchased, the company must then pay the bank rent expense from the cash flows of that asset or project. Overtime, the islamic bond is paid off in rent using fixed payments over a certain amount of time. Then the par value of the the islamic bond is purchased at a future date.
For example, Osman is looking to start a new production line in his business that will require the equivalent of $1 million dollars. Because Osman is building this line in Saudi Arabia, he plans on financing the costs using this islamic bond. He then goes and obtains the financing he needs from an islamic bank. The bank invests in the project. They decide that Osman will owe the bank rent of $80,000 per year and the final par value of the Sukuk, ($1 million) 10 years after the project is done. Notice that this is the same set up as a regular bond where the rent expense of $80,000 is equal to an 8% interest rate. And the par value of the bond is due at the end of the term like a bond.
Coupon Rate Bond
What is a Bond?
Nominal Interest Rate