What is a derivative in financial terms?

A derivative is defined as a financial instrument that has a value which is derived from an underlying asset. This underlying asset can be various types of securities, commodities, currencies, or indexes. The key characteristic of derivatives is that their price is contingent upon the price movements of these underlying assets.

Derivatives are often utilized for hedging purposes to mitigate risk or for speculative purposes to leverage potential returns. Common types of derivatives include options, futures, and swaps. They allow investors to negotiate exposure to assets without necessarily having to own the underlying asset directly, making them versatile tools in financial markets.

Understanding the nature of derivatives as instruments that derive their value from other assets is fundamental to grasping their function and applications in trading and risk management.