Derivative
Explanation: A derivative is a financial instrument whose value is derived from the value of an underlying asset, index, or rate. Common types of derivatives include futures, options, swaps, and forwards. Derivatives are used for hedging risk, speculating on price movements, and arbitraging price discrepancies between markets.
Example: A wheat farmer and a bread manufacturer might enter into a futures contract where the farmer agrees to sell a specific amount of wheat at a predetermined price on a future date. This contract helps both parties hedge against the risk of price fluctuations in the wheat market.
Reference Link: For more information on derivatives, visit Investopedia’s Derivative.
FAQs:
- What are the main types of derivatives?
- The main types include futures, options, swaps, and forwards.
- How are derivatives used for hedging?
- By entering into derivative contracts, parties can lock in prices or rates to protect against adverse price movements in the underlying asset.
- What is the difference between a derivative and a stock?
- A stock represents ownership in a company, while a derivative is a contract whose value is based on the performance of an underlying asset.
- Can derivatives be risky?
- Yes, derivatives can be highly leveraged and complex, leading to significant gains or losses.
- How are derivatives traded?
- Derivatives can be traded on exchanges or over-the-counter (OTC), depending on the type and contract terms.