Sunday, January 9, 2011

Islamic Forward contracts (Bay Al Salam) Applications

The Concept of Bay al Salam is a part of the Islamic Finance "" it was permitted by the Prophet Mohammed (peace be upon him) in order to enable contracts with delivery cannot take place at once, but in the future in addition it can be also utilized as the Islamic version of Hedging.

In this Article we will discuss a simple example on how Hedging and bay al salam works.

in this example we have two farmers Mohammed and Abudullah.

We will assume three scenarios:

Codes will be (M) for Mohammed and (A) for Abdullah:

Mohammed decided to go with bay al salam to ensure that he gets a Hedge from Price fluctuation.
Abdullah decided not to Hedge. ( he is exposed to Price volatility )

(M)

Agreed upon price of Bay al salam is (110)
Scenario 1
price Rise 25%

price rise to $100 X1.25 = $125
actual profit 110 - 100 = $10
potential loss 125-110 = $15

Scenario 2
no price change = 0 gain on future

Scenario 3
Price decline by 25%
100 / 1.25 = $80 profit
110-80 = $30  profit

(A)

Scenario 1

price rise 125-100 =$ 25 as profit

Scenario 2
no price change = 0 gain on future

Scenario 3

Price decline by 25%

80 - 100 = $20  loss on future

end of example

In the example above we have demonstrated simple Future contract following the islamic Bay al Salam method , which does not permit selling the future or forward position to profit from the intangible asset.

For more info please contact me on IslamicFinancier@gmail.com and i will answer any of your concerns in the example above.

A. (Islamic Financier )

1 comments:

Thank you very useful info

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