Pricing of Bai Salam : An Analytical Perspective

Bai Salam has gained prominence as an Islamic financial instrument for financing the deficit funding units across the Islamic world. This paper uses the arbitrage-free first order conditions to set boundaries on the ra's al-mal (the price paid in Bai Salam). Among the four schools of thought (Hanafi, Maliki, Shafi and Hanbali), Hanafi jurists strictly require, for a valid Salam contract, the existence of al-musallam fihi (the underlying asset of the Bai Salam contract) at the time of contract. This paper proposes that when al-musallam fihi exists at the time of contract the ra's al-mal must be equal to the current price of the underlying asset plus the holding cost so that there is no arbitrage. For cases where al-musallam fihi does not exist at the time of contract, a closed form formula for calculation of ra's- al-mal is being proposed. The formula will ensure fair pricing of Salam contracts in order to safeguard the interests of al-musallam alayhi (the seller of the underlying asset)