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A derivative, or derivative security, is an asset whose price is based on the value of an underlying asset. A derivative can come in several forms such as options, futures, and swaps. An option contract is a derivative that gives the owner the right, but not the obligation, to buy or sell the underlying at a predetermined price. A futures contract is a derivative that commits a party either to buy or sell the underlying in the future at a certain price. A swap agreement is a derivate that commits the counterparties to exchange cash flows according to a pre-arranged formula. For example, an interest rate swap will specify cash flows to be paid as a function of some interest rate. The term derivative is generic and variations as well as entirely different derivative types are possible. |
