Conventional Bonds: Definition and Differences from Sharia Bonds

Investing is now a popular way for many people, especially Millennials and Gen Z, to save money with added benefits. Of course, it is more profitable than just saving money in a regular savings account.

Of the many investment vehicles currently available, bonds are a fairly old form of investment and one that is popular with investors, both novice and experienced investors. Bonds themselves are considered one of the most stable investments and offer a fairly high yield.

For those who don’t know what bonds are, a bond is a capital markets term that refers to a certificate of indebtedness that the bond issuer issues to bondholders. In short, the issuer of the bond is the obligor and the bondholder is the obligor.

For bonds, the due date of the debt payments and the interest (coupon) are written, which represents the bond issuer’s obligation to the bondholder. The term of the bonds valid in Indonesia is usually 1 to 10 years.

Of the different types of bonds currently available, conventional bonds are examples of bonds that are also the most commonly traded in Indonesia.

What are traditional bonds?

Definition of conventional bonds
Traditional bonds are debt securities issued by specified parties with the aim of obtaining loans as additional capital, followed by interest or returns for investors over a set period of time.

Conventional bonds are different types of bonds that have been traded. Here are some types of conventional bonds in Indonesia:

Viewed from Coupon Payment System Viewed from the Publisher’s Side
Zero Coupon Bonds:

Bonds that do not make periodic interest payments. However, interest and principal are paid at the same time at maturity

Corporate Bonds (Corporate Bonds):

Bonds issued by companies, either in the form of state-owned enterprises (BUMN), or private business entities. Corporate bonds are divided into bonds with fixed coupons, bonds with variable coupons and bonds with sharia principles. Some corporate bonds have been rated or some are not.

Fixed Coupon Bonds (Fixed Coupon Bonds):

Bonds with an interest coupon rate that has been determined before the offering period in the primary market and will be paid periodically

Government Bonds (Government Bonds):

Bonds issued by the Indonesian government. The government issues bonds with fixed coupons (FR-Fixed Rate series), bonds with variable coupons (VR-Variable Rate series) and bonds with sharia principles/State Sukuk. For example ORI, retail sukuk.

Variable Coupon Bonds (Variable Coupon Bonds):

Bonds with an interest coupon rate that is determined before a certain period of time, based on a certain benchmark, such as the banking interest rate.

Retail Bonds:

Bonds issued by the government that are sold to individuals or individuals through a selling agent appointed by the government. Usually there are several types, namely ORI or Retail Sukuk.

Differences between Conventional and Sharia Bonds

In addition to conventional bonds, there are other types of bonds, namely Islamic bonds. Islamic bonds are an alternative for investors who want to invest in accordance with Islamic rules or sharia. Even though they are both bonds, conventional and sharia bonds certainly have differences, both in terms of understanding and how they work.

The following are the differences between conventional and Islamic bonds that you must know:

Type of Difference Conventional Bonds Sharia Bonds
Business Principles and Activities In conventional bonds, this investment relies on the principle of being free or not limited by the rules like Islamic bonds. Sharia bonds or often called sukuk. Using sharia principles in all its business activities.

The issuance of sukuk can be carried out by non-sharia issuers as long as the issuance process is adjusted to sharia principles.

Scheme Holders or buyers of debt securities, called investors, will benefit from the interest on loans they receive from the company where they invest. Using Islamic sharia principles where profits are shared with a profit-sharing system, and the profits given to bondholders are called yields.
Flower In conventional bonds, there is interest given when the bonds are returned. The return is not in the form of interest but in the form of compensation for rent or ujrah, profit sharing, and margin fees that are adjusted to the contract agreed upon by both parties.
Underlying Asset Declare debt from the issuer to the investor, where the issuance does not require an underlying asset. Sharia bonds or sukuk are securities that are issued and represent investors’ ownership of the assets that are the basis for issuing sukuk (underlying assets) without forgetting the application of sharia principles.
Use of Funds There is no limit, as long as it is not for the financing of illegal things and crimes. The use of funds from the issuance of sukuk can only be used for matters that are not contrary to shariah principles.
The nature of the instrument In conventional bonds, this type of investment is in the form of debt securities or is valued as a statement of debt from one party. In Islamic bonds or sukuk, this investment is valued as a certificate of asset purchase, where the average yield is divided according to the initial agreement made.
Income In conventional bonds, the return is in the form of interest which is already commonly used, and is not related to any funding objectives. The level of income in Islamic bonds is based on the level of profit sharing ratio (ratio) whose amount has been agreed upon by the issuer and investors.
Fees to be Paid Administrative fees and OJK levies are subject to 0.05% of the emission value or a maximum of Rp. 750 million. There are administrative fees and additional fees as wages for the Sharia Board.

Also the OJK levy fee is 0.05% of the emission value or a maximum of IDR 150 million.

Tips for Success in Earning Money by Investing in Bonds

For those who are interested in investing in bonds, be it a no-coupon bond or other types of bonds. Here are some tips that can be done in order to be successful in getting the benefits of bond investment:

1. Buying Price when it Drops

Bond prices can fall at any time, for example when inflation occurs. It’s better to buy bonds when the situation is like this and sell them when the price returns to normal so that the profits are maximized.

However, keep an eye on the type of bonds you buy. If it is not a government bond, make sure the bond is issued by a trusted corporation or company to ensure its validity.

2. Holding Bonds

If you don’t need urgent funds, selling bonds is not the right choice when the price is down. Because usually it is not only the value of bonds that fall, but also the value of other investment instruments.

Holding on to bonds is actually a bit detrimental, but only for a moment. If conditions return to normal, the bond price will also be normal or higher than the purchase price. So, no need to rush to sell it.

3. Already Diversified from the Beginning Investing

Even though you already have bonds, there’s nothing wrong with looking at deposits, stocks, or gold. Anyway, the type of investment that is in accordance with financial conditions and profitable, both in the short and long term.

Diversification helps you minimize investment losses. If the value of the bonds is going down, there are other investments that can cover the loss. Call it gold, the price is very high when inflation occurs.

4. Choose a Bond with a Weaker Maturity

The reason is simple, namely because the interest rates are higher than bonds with shorter maturities. Interest rates will provide passive benefits that can be enjoyed every year. Even if you plan to sell the bonds before maturity, it’s fine as long as the selling value is higher than the purchase value. As a result, the profits are doubled.

5. Understand the Risks

Even though bond investments are safe and stable, they still carry risks like other investment instruments. Here are 4 types of risk that exist in bond investments:

Default Risk The risk that arises if the bond issuer, both the government and the company is unable to pay the principal of the investment along with the coupon that has been agreed upon since the beginning of the investment.
Market risk The risk caused by price fluctuations in the market. If these fluctuations cannot be controlled, they have the potential to cause inflation. When inflation increases, the price of bonds themselves will decrease.
Market liquidity risk An investor who needs quick funds, but can’t find potential bond buyers will usually experience liquidity risk. It is possible for investors to sell bonds at an unreasonable price or lower than the purchase price which causes losses.
Risk of changing rules If the regulations on bonds in a country change, this will put a risk on the value of the bonds. For example, changes in income tax rates are subject to change at any time. Currently, the income tax (PPh) on bonds is 10%.

Be a Wise Investor

In investing, don’t just invest with the intention of looking for profit. But also must be wise and knowledgeable in terms of investment, especially in the type of investment chosen. This is so that you as an investor can not only get the maximum profit but can also minimize the risks that exist for both long-term or short-term investment assets.

 

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