The term ‘derivative’ refers to a type of financial contract, which changes in value depending on an underlying asset, group of assets, or index. It involves two or more parties and can be traded on the market.
Derivatives can also be traded over the counter, with individuals being able to purchase certain types through their bank. Prices for derivatives come from changes in the value of the underlying asset.
Derivatives are commonly used by investors to access certain markets or to hedge against risk. The most common underlying assets are stocks, bonds, commodities, currencies, interest rates and indices.
Traders use derivatives to hedge against risks, speculate in financial markets, or leverage holdings. Derivatives can be used to reduce risk, although they typically increase the cost of investing.
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