Emirates Airline: A Billion-Dollar Sukuk-Bond Issue Case Solution
The treasury department at the Emirates Airline had to decide about raising funds for the purchase of 30 A380 aircrafts. The company announced to issue Sukuks worth $1 billion and conventional bonds worth $750. Both types of bonds had same risk profile but the Sukuks were sold with a low implied yield. It seemed odd as compared to the conventional mode of financing because the securities with similar default risks were priced differently, as a result of which, the treasury department at the Emirates Airline hadto decide about an appropriate way of funding the next purchase of the A380 aircrafts’ batch (Emir Hrnjic, 2014).
To acquire more 30 Airbus; the company issued a 10 year amortized Islamic bond which are large organizations issue shares to generate more finance to invest in the business. So here, in this case, the company is also known as Sukuk. Sukuk had an average life of five years and it would be matured before the final maturity date. To generate finance; the company had to issue the Sukuks and purchase the new aircrafts. It was a risky option so the company involved more banks to diversify and reduce the risk.
There are two modes of financing available for the company, i.e. issuing Sukuks (Islamic Bonds) and the conventional bonds. The Sukuks financing is raised by the issuer according the Sharia principle and Islamic laws. The Sukuk bond’s face value is based upon the market value of the underlying assets. According to the Shariah principles; the interest rate and speculation are prohibited. The investors will be compensated on the basis of share of profit or loss, incurred on the underlying asset. In addition, Sukuks enable the investors to hold portion of ownership in the underlying asset, which should be directly linked with the purpose of financing.
In order to raise financing through debt in the long term; conventional bonds are used. The price or the face value is based upon the credit rating of the bonds’ issuer. The issuance of conventional bonds makes it mandatory for the issuer to pay principal and interest till the maturity of the bonds. However, the conventional bonds do not provide ownership in the share of issuer’s assets, as it is basically a debt obligation towards the investors by the issuer. Further, the risk sharing elements are also eligible under the issuance of conventional bonds.
In general, the difference between the yields of Sukuks and conventional bonds is because the Sukuks do no refer to a debt obligation as it instead provide ownership in the underlying asset. However, the conventional bonds refer to a debt obligation but not the ownership in the underlying asset. The Emirates Airline issued 10 year Sukuks at a yield of 3.875%; however, the 12 year conventional bonds were issued at a yield of 4.5%. At issuance, the yield curve indicated that both the bonds should be offering similar profit rate; however, the yield of Sukuk bonds was 48.6 bps less than the yield of the conventional bonds.
In relation to risk, the Sukuks and the conventional bonds has same risks especially in the rate of return risk. For instance, the market interest rate has increased but the fixed returns on Sukuks are unable to rise, which would lead towards less earnings on Sukuks. However, such rate of return can also be available in the conventional bonds. In addition, the credit risk arises both in the conventional and the Sukuks. According to Shariah principle, the credit risk management instruments will not be available under the Sukuks issuance. This is because, Sukuks are usually issued in the emerging markets, whereby the counter parties with a low risk management mechanism are more likely to default on the commitments. The only risk faced by the issuer is the compliance of the Shariah standards, whereby the underlying asset can’t be changed and if changed, will make the Sukuk certificate rendered as null and void.From the price perspective, there is a negative relationship between the bond’s price and the bond yields. If the interest rate increase, it will lead to decrease in the bond’s price as the bonds will be sold at discounted price in order to attract more investors. On the other hand, if the demand for bonds increases, it will lead to increase in the price of bonds and ultimately a decrease in the bond yield. After the global crisis of 2008, people started seeking alternative modes of financing based on the Shariah Standards, as a result of which the demand for Islamic financing grew rapidly, resulting in Sukuks being reported as lower yielding in comparison to to conventional bonds.
In addition, the 12 year conventional bonds had a longer maturity period as compared to Sukuks, which led to increased risk and yield over the conventional bonds. The maturity period has affected the yields of the Sukuks and the conventional bonds, as it might come up with different risk levels, ultimately, impacting the price and yield of the bond (Mohammad, 2014)………………………….
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