Commodity Linked Notes and Bonds

Definition of "Commodity Linked Notes and Bonds"

A proposed financial instrument for Islamic financial market. This instrument is ideal for raising capital by enterprises whose revenues are dependent on a particular commodity. Example: An oil refiner buys crude oil in spot market and intends to sell it after processing as refined products. An investor enters into agreement with the refiner to provide funds for buying a specified number of barrels of crude oil on the spot. In return, the investor will get periodic returns based on an index of representative refined oil products prices or the spread between crude and refined oil products and a pre-defined deduction for the processing cost of the crude. At maturity of the contract, the investor will receive its principal back. The borrower can benefit by reducing the cost of processing and the investor can benefit from a wider spread between crude and refined oil. Commodity bonds can be introduced in different flavours. Principal amount of the bond will always have to be stated in terms of a commodity. Coupon can be linked to an index of a commodity or a basket of commodity prices. For an index to be permissible under the shari‘ah, it must be an index of the specific trades. For example, in the case of grains it must be an index of the specific grains in the contract; for real estate, it must be an index of the real estate in question and cannot be a general or representative real estate index.