Finance Dictionary
Derivative
Definition
A financial security with a value that is reliant upon or derived from an underlying asset or group of assets.
Deep Dive
A derivative is a financial contract whose value is "derived" from an underlying asset, group of assets, or benchmark. These complex financial instruments are often used for a variety of purposes, including hedging against risk, speculating on future price movements, and exploiting arbitrage opportunities. Investors can use derivatives to gain exposure to an underlying asset without actually owning it, making them powerful tools for both risk management and amplifying potential returns (or losses).
Examples & Use Cases
- 1An airline might use oil futures contracts to lock in a future price for jet fuel, hedging against potential price increases.
- 2An investor might buy call options on a technology stock, speculating that its price will rise significantly before the option expires.
- 3Two corporations might enter into an interest rate swap to exchange fixed-rate interest payments for floating-rate interest payments, managing their exposure to interest rate fluctuations.
Related Terms
OptionsFuturesHedging