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In Islamic finance, money is only considered as a medium of exchange and does not have intrinsic value on its own; because of that, if the money is idle (left in the bank or lent to other people) and not used in business, then money should not increase. On the other hand, Islamic finance considers that the human endeavor, initiative, innovation, creativity, and risk inherent in productive business are more important than the money used to fund the project itself. Money is considered capital only if it is invested in business and the investors accept the possibility of loss or failure in business; thus, investment also opens the possibility of growing. If the money is given to a business in the form of a loan, instead of equity, then because it is debt instead of capital, the money has no right to any return generated by the business (like interest). This is because money only has a time value when it is invested as capital, not when it is idling as “potential capital.” Besides, Islam does not consider loan (or debt) as an income-generating transaction.

Money, Time Value of Money, and the Discounted Model in Islam

Islam forbids the practice of usury in all its forms, such as a discounted debt (borrowing $1,000 for a period of 3 months, but the money received at the beginning is only $950, and the borrower is required to return exactly $1,000 at the due date), an interest-bearing debt (borrowing $1,000 for three months with an interest rate of 12 % per annum, thus accepting $1,000 in cash at the beginning and being required to return $1,030 at the end of the three month period), or a return for the due date extension (borrowing $1,000 for three months, without interest, and receiving $1,000, but failing to pay at the due date; the lender extends the due date and asks for an additional payment or late payment penalty of 0.01 % per day of delay). This prohibition of usury emphasizes that it is not allowed to apply an indexing method or a discounted model in the case of a debt or loan contract.

On a debt-based sales contract, it is allowed in Islamic finance to set a price that is different from the current market price; a mu'ajjal contract uses a price that is higher than the current market rate (at premium), and a salam contract uses a price that is lower than the current market rate (at discount). Indirectly, Islamic finance accepts the possibility of price different between immediate cash payment and those where the delivery of goods and the delivery of the payment do not coincide in timing; this is an example of the existence of time value of money for the deferral of cash acceptance or goods acceptance. When the price is determined at the beginning of the contract, the profit margin can be immediately recognized, and as long as there is no defaulting payment, then that is also the amount of profit that will be realized. Considering the way price and margin are formed, this mu'ajjal contract is similar with discounted debt. The difference in discounted debt is that in a pure debt (li-tabarru' contract), there are no goods or services that needs to be delivered to the borrower (except for money), because according to the syari'ah the lender has no claim over the difference of what is paid and what is accepted without bearing a part of the risk (other than the risk of default). While in a mu'ajjal contract, the seller transfers the goods to the buyer, where previously the seller must hold the goods and thus bear the market and product risks, and for that cause, according to the syari'ah, the seller has the right to claim the difference between the sale price and the cost of goods sold as profit margin.

Risk-Free Assets in Islamic Finance

Risk-free assets imply that the asset will still give a positive return to its holder, no matter the business condition that has befallen on the firm that issued it, regardless of whether it has succeeded or failed. Other than that, an asset is said to be risk-free if the return that it generates is constant and invariant through time. This term is better known from the CAPM, where the risk-free asset is associated with the opportunity cost borne by the investor when the investor takes additional risk in a project. The investor requests additional return as a compensation for venturing beyond the status quo in placing his or her funds on financial instruments (assets) with a positive yield, and yet risk-free. Here, it is assumed that (1) money can generate real income from itself; (2) alternative projects always generate positive yield; and (3) there is no risk associated with alternative projects; and these three assumptions are frankly not true. Apart from opportunity cost, the concept of the risk-free asset also represents the decline of purchasing power caused by inflation. When there is a positive inflation, if the nominal amount of money does not increase, then within the year, the real value of the money will decline by the same amount as the inflation rate. This is why when investors decide to invest, there is a potential loss if the yield of the project is smaller that the ongoing rate of inflation.

There are three possibilities of implementation of the concept of risk-free asset: qardh (loan or debt), debt-based sale contract (salam or mu'ajjal), and partnerships or syirkah (mudharabah, musyarakah). In the first case, the application of the concept of the risk-free asset will cause the payment of debt to be larger than what is received by the borrower. For whatever reasons, whether due to opportunity cost or compensation over the effects of inflation, this nominal addition to the future value is not allowed in Islam, and falls under usury. In the second case, the concept of the risk-free asset is used to determine the size of the margin in a mu'ajjal sale or the discounted price in a salam price, and this is allowed in Islamic finance. In the third case, the application of the concept of risk-free asset is only allowed as a benchmark and cannot be set as a predetermined rate of return. This concept can only be used to simulate the ratio for the preferred rate of return and estimate the yield with that ratio. But, after the ratio is set, the realization of the return will rely on the realization of the profit or loss of the business. Thus, different from the second case, on syirkah, the application of the concept of the risk-free asset is abstract and not real.