What is Bond?
Obligatsiya
In short
A debt security issued by a company or government: the holder receives fixed interest and the principal at maturity. Because it is interest-based, conventional bonds are not used in a halal portfolio.
Also known as: bond, obligatsiya, treasury
A bond is a debt security issued by a company or a government. Buying it means lending money: the investor receives fixed interest (the coupon) during the term and gets the principal (face value, usually $1,000) back at maturity. US government bonds are called "treasuries".
How it differs from a stock
A stock is an ownership stake: profits and losses are yours and income is not guaranteed. A bond is a loan: the holder is a creditor, not an owner. In bankruptcy creditors are paid before shareholders, which is why bonds usually swing less.
Price and interest rates
Bond prices move opposite to market interest rates. When rates rise, older bonds with lower coupons become less attractive and their prices fall. The longer the maturity, the stronger the effect.
The halal angle
A conventional bond's income is predetermined interest. The AAOIFI standard and most Islamic finance scholars treat such interest as riba, so conventional bonds are not used in a halal portfolio. The asset-based alternative is the sukuk. A company's interest-bearing debt also matters when its stock is screened — details in the methodology.
For information only, not a fatwa.
Example
A hypothetical corporate bond: face value $1,000, coupon 5%, term 10 years.
- Each year: $1,000 × 5% = $50 of interest
- Over 10 years: $500 of interest plus the $1,000 returned at maturity
Now suppose market rates rise to 6% after the bond is issued. If new bonds pay $60, nobody will pay $1,000 for the old one paying $50. By the math its price drops to about $926 — at which point the yield for a new buyer is around 6% again. Even a "safe" bond can lose money on price.
Mistakes and tips
Bonds are not risk-free: there is rate risk, inflation risk and the risk that the issuer defaults.
If you are building a halal portfolio, check what bond funds and balanced funds hold — they usually contain interest-bearing paper.
When analysing a stock, look at the debt the company has raised through bonds: debt-to-equity and interest coverage.
Frequently asked questions
- Are bonds halal?
- Because a conventional bond is interest-based, Islamic finance standards such as AAOIFI do not permit it. Sukuk are used as the alternative; for a specific question, consult a qualified scholar.
- Why do bond prices fall when interest rates rise?
- New bonds start paying higher coupons, so an older low-coupon bond gets cheaper until its yield matches the new rate.
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