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Derivative

A derivative is a financial instrument derived from underlying assets like stocks, currency, index, commodities, etc. They are called derivatives as they are derived from other financial instruments.

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Derivative means, deriving its value from underlying asset or group of assets. It is generally a contract between two parties to buy or sell the underlying asset at a future date on currently agreed upon prices.

The common underlying assets include stocks, commodities, currencies and indexes.

There are 4 types of derivatives-

  1. Futures- A contract between two parties wherein the buyer agrees to purchase a fixed number of shares or any other underlying asset a specific time in the future for a predetermined price. The buyer is obligated to purchase.
  2. Options- Options are contracts that give the buyer the right to buy the asset at a predetermined price. But there is no obligation on the buyer to purchase. If the buyer chooses to buy, the seller is obliged to sell it.
  3. Forwards - Forwards are unregulated contracts between two private parties and are traded over-the-counter (OTC).
  4. Swaps- These are unregulated contracts wherein financial instrument are exchanged between two parties. The exchange takes place at a predetermined time, as per the contract.

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