FINANCIAL
MANAGEMENT
ASSIGNMENT 2
ALINA ALI
FINANCIAL MANAGEMENT ASSIGNMENT 2
Q1. What are Sukuk bonds and how do they work in Pakistan?
SUKUK BONDS
Sukuk bonds are defined as the:
Securities of equal denomination representing individual ownership interests in a portfolio of
eligible existing or future assets.
In simple words a Sukuk is basically an Islamic financial certificate which complies with Islamic
religious law commonly known as Sharia. Since the traditional Western interest-paying bond
structure is not permissible, the issuer of a Sukuk sells an investor group a certificate, and then
uses the proceeds to obtain an asset, of which the investor group shares partial ownership. The
issuer is obliged to make a contractual promise to buy back the bond at a future date at
par value.
Sukuk bonds are basically developed as an alternative to conventional bonds which are not
considered permissible by many Muslims as they pay interest and may finance businesses that
are involved in non-Sharia-compliant activities, for example gambling, alcohol, etc. Sukuk
securities are structured to comply with Sharia by paying profit, not interest that is done
generally by involving a tangible asset in the investment.
Thus, sukuk represents aggregate and undivided shares of ownership in a tangible asset as it
relates to a specific project or a specific investment activity. Hence, an investor in a sukuk, does
not possess a debt obligation owed by the bond issuer, but instead owns a piece of the asset
that's linked to the investment. This means that sukuk holders, unlike bond holders, receive a
portion of the earnings generated by the associated asset. Sukuk bond financing is only raised
for recognizable assets because of the way they are structured
GOP Ijara Sukuk is one of the most common examples of sukuk bonds in Pakistan that are in
line with the Sharia. Ijara sukuk are issued by the Government of Pakistan (GOP) to general
public which are then distributed by different banks (acting as the sub-custodian) while State
Bank of Pakistan is the main custodian of these bonds.
Sukuk bonds are a medium term investment on which SBP announces guaranteed profits every
6 months. Income tax is deducted from these bonds as per the law.
Sukuk securities may have partial ownership of a property built by the investment company and
held in a Special Purpose Vehicle, so that Sukuk holders can collect the property's profit as rent,
which is allowed under Islamic law.
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FINANCIAL MANAGEMENT ASSIGNMENT 2
There are many different types of sukuk which are based on different structures of Islamic
contracts like Murabaha, Ijara, Istisna, Istithmar, etc. depending on the project that the Sukuk is
financing.
HOW DO SUKUK BANKS OPERATE?
1) Opening an Investor Portfolio Securities (IPS) account:
SBP appoints the primary dealers of government for each financial year which offers IPS
accounts to all the people and entities that hold a certain PKR account with the primary dealer
or any other scheduled bank that is offering the facility.
Initially the investor is required to make an Investor Portfolio Securities (IPS) account for the
purpose investing in sukuk bonds. IPS account opening branch delivers activity statements of
IPS account to each investor four times a year (quarterly). Banks clearly mention their charges
on IPS accounts as per the policies.
2) Buying Sukuk Bonds:
After an IPS account is opened, Sukuk bonds can be acquired either from the primary market (in
which the government floats) or from the secondary market. Banks undertake the responsibility
of holding the bonds in IPS accounts on behalf of the investor. The investor then becomes the
legal owner of these bonds which were held in the IPS account.
3) Profit Payment:
Government declares profit on Sukuk bonds twice a year (semi –annually) on the basis of rental
rate announced by SBP prior to start of each semi-annual period. Also the amount of profit is
credited to the account of investor through its primary dealer (bank).
4) Maturity of Sukuk bonds:
When Sukuk bonds reaches its maturity investor’s account is credited by the PKR amount
equivalent to the face value of Sukuk bond. Sukuk bonds are only redeemable at maturity
however; they can be sold in secondary market through prime dealer.
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FINANCIAL MANAGEMENT ASSIGNMENT 2
Q2) how is the bond market in Pakistan and how can it and overall debt market
improve? What role can government play?
In Pakistan, the development of money market and bond market was initiated in late 1990s
after the liberalization reforms; however, Pakistan's bond market has developed at a slow pace
as compared to other countries. Like other emerging markets, most of the debt financing is
done through bank borrowings. In 2000, government bond market showed significant growth
after the introduction of Pakistan Investment Bonds .Securities and Exchange Commission of
Pakistan (SECP) regulates bonds in Pakistan.
HOW DOES THE BOND MARKET OPERATE?
The bond market is divided into 2 different sections; the primary market and the secondary
market.
Primary Market
Primary market deals with the issuance of new securities. Public institutions, government,
companies they can raise capital through the sale of a new sock or a bond issue, this is referred
to as Initial Public Offering (IPO). The company in need of finance goes to an investment bank
where the investment bank creates the legal structures, sets the price (yield), and then goes to
its investors to get the money. In exchange for their money, investors are given a promise of
the company to pay them back the principal amount along with the interest. The Dealers also
earn commission that is built into the price of security offering.
Secondary Market
Secondary market are markets in which existing bonds are subsequently traded among
investors, meaning that the investor already possesses a bond and further wishes to raise
capital. The investor can exchange its bond for cash by reselling it to another investor for fur
father financing. The bond trader then goes to a new investor, agree on a price and make a
deal.
The bond market is effected when expectations regarding economic growth and inflation
changes. The higher the investors assume of inflation to rise, the less they will pay for bonds
and vice versa. In bond market, lower prices correspond to higher yields, and higher prices
correspond to lower yields. When prices fall, yields rise, and vice versa.
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FINANCIAL MANAGEMENT ASSIGNMENT 2
ROLE GOVERNMENT CAN PLAY TO IMPROVE THE BOND MARKET AND
DEBT MARKET
In Pakistan, there has been over-dependence on the banking system to fulfill the financing
needs of the economy, with capital markets relatively slower to develop in comparison.
How Can Bond & Debt Market Improve?
The overall debt market has not been really effective for portfolio flows like other rising
markets; also the basic principles which are applicable to debt management are being
compromised. Stable economic conditions are essential and directly linked with the
development and growth of financial markets. The processing period of TFC approval at the
SECP should be minimized. New regulations should be introduced by SECP for the purpose of
earning investor’s confidence in different financial instruments. For an efficient debt market, it
is the need of the hour to look for options that diversifies risks, provided greater return and
fosters investment. A sound institutional framework should be made for debt management
with appropriate governance structure to strengthen the market related activities in corporate
bond market.
GOVERNMENT’S ROLE
It is essential for government to play market-completion role in the development of the debt
market. As the primary issuer of sovereign bonds of various tenors, the government effectively
needs to establish the benchmark for the pricing of private sector debt instruments .In doing
so; it catalyzes the development of the financial system. Government should be responsible to
provide an outline that helps investor to properly invest and exchange debt instruments. The
extension of the maturity profile of debt issuance might also ease the emergence of a risk-free
yield curve across the term structure. Timely market information should be provided by
government to parties involved such as investors, issuers, deals etc. in order to make sound
decisions regarding investments.
Government should also come up with a proper calendar to address for PIB auctions and
explicitly mention its targets. It can also review the stamp duty on TFCs to improve the cost of
issuing TFCs for the growth of TFC market. The government should issue government debt as it
is vital for backing the development of the debt market. Also it’s required to pay enough
attention for bringing improvements in primary and secondary market along with the
development of short term to long term securities.
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FINANCIAL MANAGEMENT ASSIGNMENT 2
REFERENCES
http://www.sbp.org.pk/dmmd/Guidelines/Sukuk.pdf
https://en.wikipedia.org/wiki/Sukuk
https://www.imoney.my/articles/investing-in-sukuk-how-does-it-work
https://www.quora.com/How-does-the-bond-market-work
https://www.thestreet.com/investing/frequently-asked-questions-about-the-bond-market-1087488
https://ift.world/booklets/3-primary-and-secondary-bond-markets/
https://fp.brecorder.com/2019/01/20190103436779/
http://www.sbp.org.pk/FSR/2010/pdf/1RoleofGovernment.pdf
http://www.sbp.org.pk/fscd/2007/Presentations/Bond-Market.pdf
https://www.thestreet.com/investing/frequently-asked-questions-about-the-bond-market-1087488
http://www.sbp.org.pk/ecodata/Auction-Investment.pdf
http://www.sbp.org.pk/research/IIndConf/Developing-Bond-Market.pdf
https://profit.pakistantoday.com.pk/2019/10/21/good-news-bond-market-is-signalling-an-economic-
recovery-but-heres-why-that-just-might-be-bad-news/
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