Derivatives: In finance, a derivative is a contract that derives its value from

the performance of an underlying entity. This underlying entity can be an asset,

index, or interest rate, and is often simply called the "underlying". Derivativ
es can be used for a number of purposes, including insuring against price moveme
nts (hedging), increasing exposure to price movements for speculation or getting
access to otherwise hard-to-trade assets or markets.[3] Some of the more common
derivatives include forwards, futures, options, swaps, and variations of these
such as synthetic collateralized debt obligations and credit default swaps. Most
derivatives are traded over-the-counter (off-exchange) or on an exchange such a
s the Bombay Stock Exchange, while most insurance contracts have developed into
a separate industry. Derivatives are one of the three main categories of financi
al instruments, the other two being stocks (i.e., equities or shares) and debt (
i.e., bonds and mortgages).
What is a derivative?
A derivative is a contract between two or more parties whose value is based on a
n agreed-upon underlying financial asset, index or security. Common underlying i
nstruments include: bonds, commodities, currencies, interest rates, market index
es and stocks.
Futures contracts, forward contracts, options, swaps and warrants are common der
ivatives. A futures contract, for example, is a derivative because its value is
affected by the performance of the underlying contract. Similarly, a stock optio
n is a derivative because its value is "derived" from that of the underlying sto
ck.
Derivatives are used for speculating and hedging purposes. Speculators seek to p
rofit from changing prices in the underlying asset, index or security. For examp
le, a trader may attempt to profit from an anticipated drop in an index's price
by selling (or going "short") the related futures contract. Derivatives used as
a hedge allow the risks associated with the underlying asset's price to be trans
ferred between the parties involved in the contract.
For example, commodity derivatives are used by farmers and millers to provide a
degree of "insurance." The farmer enters the contract to lock in an acceptable p
rice for the commodity; the miller enters the contract to lock in a guaranteed s
upply of the commodity. Although both the farmer and the miller have reduced ris
k by hedging, both remain exposed to the risks that prices will change. For exam
ple, while the farmer locks in a specified price for the commodity, prices could
rise (due to, for instance, reduced supply because of weather-related events) a
nd the farmer will end up losing any additional income that could have been earn
ed. Likewise, prices for the commodity could drop and the miller will have to pa
y more for the commodity than he otherwise would have.
A derivative is a contract between two or more parties whose value is based on a
n agreed-upon underlying financial asset, index or security. Common underlying i
nstruments include: bonds, commodities, currencies, interest rates, market index
es and stocks.
Futures contracts, forward contracts, options, swaps and warrants are common der
ivatives. A futures contract, for example, is a derivative because its value is
affected by the performance of the underlying contract. Similarly, a stock optio
n is a derivative because its value is "derived" from that of the underlying sto
ck.
Derivatives are used for speculating and hedging purposes. Speculators seek to p
rofit from changing prices in the underlying asset, index or security. For examp
le, a trader may attempt to profit from an anticipated drop in an index's price
by selling (or going "short") the related futures contract. Derivatives used as
a hedge allow the risks associated with the underlying asset's price to be trans
ferred between the parties involved in the contract.
For example, commodity derivatives are used by farmers and millers to provide a
degree of "insurance." The farmer enters the contract to lock in an acceptable p
rice for the commodity; the miller enters the contract to lock in a guaranteed s
upply of the commodity. Although both the farmer and the miller have reduced ris
k by hedging, both remain exposed to the risks that prices will change. For exam

ple, while the farmer locks in a specified price for the commodity, prices could
rise (due to, for instance, reduced supply because of weather-related events) a
nd the farmer will end up losing any additional income that could have been earn
ed. Likewise, prices for the commodity could drop and the miller will have to pa
y more for the commodity than he otherwise would have.
Some derivatives are traded on national securities exchanges and are regulated b
y the U.S. Securities and Exchange Commission (SEC). Other derivatives are trade
d over-the-counter (OTC); these derivatives represent individually negotiated ag
reement between parties.