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Derivative Security

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A derivative security is an asset whose price is based on the value of some other underlying asset. An option is one type of derivative security. The futures contract is another type of derivative security. The swap is yet a third major type of derivative security. An option contract is a right (not the obligation) to buy or sell an underlying asset at a predetermined price is a derivative security. A futures contract is a commitment to buy or sell an asset in the future at a certain price. A swap is an agreement to exchange cash flows according to pre-arranged formula. The swap is a derivative security that depends upon some fundamental economic price such as an interest rate, in the case of an interest rate swap. The term derivative security is very generic and other types are possible. An exchange can institute a new derivative security when a market for trading it appears supportable.



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