Derivative (finance)

In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements: an item (the "underlier") that can or must be bought or sold, a future act which must occur (such as a sale or purchase of the underlier), a price at which the future transaction must take place, and a future date by which the act (such as a purchase or sale) must take place. A derivative's value depends on the performance of the underlier, which can be a commodity (for example, corn or oil), a financial instrument (e.g. a stock or a bond), a price index, a currency, or an interest rate. Derivatives can be used to insure against price movements (hedging), increase exposure to price movements for speculation, or get access to otherwise hard-to-trade assets or markets. Most derivatives are price guarantees. Some derivatives are based on the occurrence of specific events or measurable outcomes rather than directly on market prices. Agricultural and energy companies use derivatives to hedge risks such as weather conditions and commodity price fluctuations. Derivatives can be used to protect lenders against the risk of borrowers defaulting on an obligation. Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Mercantile Exchange, while most insurance contracts have developed into a separate industry. In the United States, after the 2008 financial crisis, there has been increased pressure to move derivatives to trade on exchanges. Derivatives are one of the three main categories of financial instruments, the other two being equity (i.e., stocks or shares) and debt...