Derivative

Definition

A derivative is a financial instrument whose value depends on the value of an underlying asset, index, or rate. Common forms of derivatives include futures, options, and swaps.

5 Must Know Facts For Your Next Test

1. Derivatives can be used to hedge against risks such as currency fluctuations and interest rate changes.
2. The primary types of derivatives are forwards, futures, options, and swaps.
3. Exchange-traded derivatives offer more liquidity and less counterparty risk compared to over-the-counter (OTC) derivatives.
4. Derivatives can be used for speculative purposes to profit from changes in the underlying asset's price.
5. Regulations like the Dodd-Frank Act have increased transparency in the derivatives market.

Review Questions

• What are the main types of derivatives used in financial markets?
• How can derivatives be utilized for risk management?
• What are some key differences between exchange-traded and over-the-counter (OTC) derivatives?

Related terms

Futures Contract: A standardized contract to buy or sell an asset at a predetermined price at a specified time in the future.

Option: A financial derivative that provides the right, but not the obligation, to buy or sell an asset at an agreed-upon price before a certain date.

Swap: A derivative contract through which two parties exchange financial instruments or cash flows.