The conviction means that Zia, head of the Bangladesh Nationalist Party, will be barred from running in the next national elections scheduled for December.
Clashes were reported between security forces and her supporters who had defied security measures to escort the auto taking Zia to court.
Zia, was sentenced by the Special Court-5 in Dhaka, in connection with the embezzlement of 2,52,000 dollars in foreign donations meant for Zia Orphanage Trust.
Zia's Bangladesh Nationalist Party threatened to start broader antigovernment protests, prompting police to ban gatherings and rallies in the capital.
The verdict came four years after Zia and others were indicted in the case.
Police have set up check-posts at key entry points of the city in an effort to prevent thousands of rural supporters of BNP and its Islamist allies from marching to the capital.
Judge Mohammad Akhteruzzaman said he was satisfied that the court had proved the charges against Zia, and said the sentence had been made more lenient than it would have been otherwise.
Law Minister Anisul Haq told journalists that " she (Khaleda Zia) will land in jail today".
Ex-Bangladesh PM Khaleda Zia sentenced to 5 years in graft case
Many private schools declared a holiday in anticipation of the verdict, while several ride-hailing services suspended operations for the day. "No way we will accept this verdict", BNP secretary general Fakhrul Islam Alamgir told AFP after the hearing. "If the Awami League can use the opportunity to go to town over Khaleda's corruption, they can minimise the impact of anti-incumbency", the diplomat said, adding that the verdict in another corruption case involving Khaleda was lined up later this month.
Police tear-gassed thousands of Zia's supporters to break up protests before the verdict was announced. Anticipating blockades and protests, the government had detained several senior BNP leaders, while several others have gone into hiding.
Tarique Rahman has been staying in London ever since he left the country in 2008 shortly after he was freed from the jail during the military-controlled emergency government.
Zia, 72, and Hasina, 70, are known as the "Battling Begums" for their bitter rivalry that has poisoned Bangladeshi politics for almost three decades.
Zia's elder sister, her sisters-in-law, her younger brother, nephews and her lawyers accompanied her to the court.
Her party boycotted the 2014 polls over its demands for an election-time non-party government, and became the Opposition outside parliament.
Asif Nazrul, Professor of law at Dhaka University, calls it "a controversial verdict".
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