Derivative

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DEFINITION of 'Derivative'

A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.

INVESTOPEDIA EXPLAINS 'Derivative'

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.

Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using U.S. dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.

Let's practice our knowledge of derivatives - Read The Barnyard Basics of Derivatives and Derivatives 101

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RELATED FAQS
  1. How can derivatives be used to earn income?

    One strategy for earning income with derivatives is selling options to collect premium amounts. Often, options expire worthless, ... Read Full Answer >>
  2. How is the price of a derivative determined?

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  3. What expiry months are typically available for derivatives?

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  4. What is the difference between derivatives and swaps?

    Derivatives are securities with prices dependent on one or multiple underlying assets. Common derivatives include forward ... Read Full Answer >>
  5. What does it mean to be long or short a derivative?

    A derivative is a type of security in which the price of the security is dependent on one or more underlying assets. A derivative ... Read Full Answer >>
  6. What is an over-the-counter derivative?

    A derivative is a type of security in which the price of the security depends on the price of the underlying asset. Depending ... Read Full Answer >>
  7. How can an investor terminate a derivative contract?

    Most derivatives contracts have provisions allowing for early termination and netting out the initial investment. The early ... Read Full Answer >>
  8. How big is the derivatives market?

    The derivatives market is, in a word, gigantic, often estimated at more that $1.2 quadrillion. Some market analysts estimate ... Read Full Answer >>
  9. What does it mean to take delivery of a derivative contract?

    When trading derivative contracts for options, a buyer or holder may have to take delivery of the underlying asset if the ... Read Full Answer >>
  10. How can derivatives be used for speculation?

    Derivative securities could be bought or sold to speculate on the future price of the underlying assets. Derivative securities' ... Read Full Answer >>
  11. What does it mean to roll a derivative contract?

    A derivative is a financial instrument in which the price of the derivative is dependent on an underlying asset. A derivative ... Read Full Answer >>
  12. How can derivatives be used for risk management?

    Derivatives could be used in risk management by hedging a position to protect against the risk of an adverse move in an asset. ... Read Full Answer >>
  13. What happens when a security reaches its strike price?

    In the derivatives market, moneyness describes the situation in which a derivative is either in the money, at the money or ... Read Full Answer >>
  14. What securities can I use to engage in speculation of an asset while limiting my ...

    If you want to engage in speculation of an asset while limiting your costs, use a derivative security. Since a derivative ... Read Full Answer >>
  15. Did the repeal of the Glass-Steagall Act contribute to the 2008 financial crisis?

    The repeal of the Glass-Steagall Act was a minor contributor to the financial crisis, if it contributed to the crisis at ... Read Full Answer >>
  16. Is a person registered for Financial Instruments Business eligible to conduct both ...

    A person in the financial instruments business, as defined by the Financial Instruments and Exchange Law, is allowed to engage ... Read Full Answer >>
  17. What are the most common leveraged ETFs that track the drugs sector?

    The most common leveraged exchange-traded funds (ETFs) that track the pharmaceutical industry are the two offered by Proshares: ... Read Full Answer >>
  18. What are the most popular mutual funds that invest in the automotive sector?

    There are few mutual funds that invest with a primary focus in the automotive industry, although major auto companies such ... Read Full Answer >>
  19. What are the biggest risks involved with financial spread betting?

    Financial spread betting is a type of financial derivatives product used to speculate the price movements of a security. ... Read Full Answer >>
  20. What are examples of popular companies in the banking sector?

    Banking sector stocks, considered among the safest investments, are a perennial favorite with investors and are also popular ... Read Full Answer >>
  21. Is financial spread betting considered an investment?

    Financial spread betting is considered an investment because investors may trade derivatives that are based on particular ... Read Full Answer >>
  22. Does common stock offer the best investment vehicle in a company or sector?

    The best investment vehicle depends on an individual investor's risk tolerance, time horizon and goals. Common stock is paradoxical, ... Read Full Answer >>
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    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  24. How did derivatives trader Nick Leeson contribute to the fall of Barings Bank?

    When an earthquake shook Kobe, Japan in 1995, it also broke open an ongoing scandal within the walls of Barings Bank. At ... Read Full Answer >>
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