In finance, a derivative is a security with a price that is dependent upon or derived from one or more underlying assets. The derivative itself is a contract between two or more parties based upon the asset or assets. Its value is determined by fluctuations in the underlying asset.
The value of this kind of financial contract (a derivative) is dependent on several factors such as an underlying asset, group of assets, or a benchmark. The derivative itself is set between two or more parties that can trade on an exchange or over-the-counter (OTC).
A derivative contract is pretty flexible so it can be used to trade any number of assets, but it can carry its own risks. Prices for derivatives can vary greatly, based on fluctuations in the underlying asset.
Derivatives are commonly used to access certain markets and may be traded to hedge against risk. In relation to risk and to fulfill their function of financial securities, derivatives can be used to either mitigate risk (hedging) or assume risk with the expectation of commensurate reward (speculation). They can also shift some of the risks inherent to the asset (and the accompanying rewards) from the risk-averse participants or investors to the risk seekers.
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