what is a derivative?
Contract for the Sale of Wheat, Thirty-fifth year of Darius, 487 B.C."
A derivative is a financial instrument that references an underlying asset from which its value is derived and entered into to meet the parties' purposes. This definition of derivative can be broken down into three parts.
The INSTRUMENT can be the following:
- Over-the-counter derivatives: options, forwards, and swaps
- Structured products: notes, warrants, and certificates
- Exchange-traded products: options and futures
The UNDERLYING asset that one of these instruments tracks can include the following:
- Equity
- Credit
- Commodities
- Interest rates
- FX currencies
The PURPOSE for entering into a transaction on one of these instruments can be for:
- Reducing transaction costs
- Maximizing portfolio returns
- Tax mitigation
- Hedging operation
- Speculation