What is a financial derivative?

A financial derivative is defined as a financial contract whose value is derived from the price of an underlying asset, such as stocks, bonds, commodities, currencies, or interest rates. This characteristic distinguishes derivatives from tangible assets, which have intrinsic value and are directly stored or owned.

Derivatives can take various forms, including options, futures, forwards, and swaps, and they are often used for hedging risks or for speculative purposes. By leveraging the price movements of the underlying assets, derivatives allow investors to gain exposure to changes in market conditions without directly owning the assets themselves.

Understanding the role of a derivative is essential in financial markets, particularly for risk management and investment strategies. Recognizing that it is a financial contract rather than a physical asset or loan highlights its unique nature in the context of financial management.