What are derivatives? – Definitions and types are defined.

Derivatives are financial instruments that derive their value from an underlying asset or group of assets. They allow investors to speculate on future price movements without actually owning the asset itself. There are various types of derivatives, each serving different purposes in the financial markets.

Futures contracts are one type of derivative that obligates the buyer to purchase an asset at a predetermined price on a specified future date. This can be used by investors to hedge against price fluctuations or to speculate on the future price of an asset.

Options are another common type of derivative that give the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price within a specified time frame. This provides flexibility for investors to take advantage of market movements without being locked into a specific transaction.

Swaps are derivative contracts where two parties agree to exchange cash flows or assets based on predetermined terms. This can be used to hedge against interest rate or currency fluctuations, or to adjust the risk profile of an investment portfolio.

Overall, derivatives play a crucial role in modern financial markets by providing liquidity, risk management, and investment opportunities for market participants. Investors should carefully consider the potential risks and rewards associated with derivatives before incorporating them into their investment strategies.

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