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.

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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