A derivative is a financial product that functions very similarly to a stock. Anyone can buy a derivative, and the value of it depends on the value of the underlying asset. For example, the value of a gold derivative is derived from the price of gold. If the price of gold increases, the value of the gold derivative increases.

Derivatives are a way of making money without holding the physical good. If someone thought the price of gold would increase, they could buy a bunch of gold bars to later sell, but that would be very difficult to store. So, they take a bet on the price of gold increasing by purchasing derivatives. That way, they will still make money if the price increases, but don’t have to deal with owning a bunch of gold bars.

Derivatives can come in many forms, but the essence of a derivative is that the price of it depends on the price of something else. Some common types of derivatives can include futures, swaps, and options.

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AuthorIsabel Munson