According to the CFA Institute, the most common definition of a derivative is that it is “a financial instrument that derives its performance from the performance of an underlying asset.’’
There are two general classes of derivatives, forward commitment and contingent claims that are either traded on organized exchanges or over-the-counter (OTC) markets. OTC markets are decentralized markets that are not regulated.
Forward commitments require the parties to transact in the future at a predetermined price.They include products such as forward contracts, futures contracts, swaps.
Contingent claims give the right not the obligation to transact at a predetermined price and include instruments such as options, credit derivatives, asset-backed securities and hybrid instruments.
Derivatives generally transform the performance of the underlying asset before paying it out in the derivatives transaction. Derivatives underlying include assets such as equities, fixed-income instruments & interest rates, currencies, credit, commodities and other less common underlyings that are not assets (e.g. weather, electricity…).
These instruments are usually used for hedging (i.e. risk management), speculation or arbitrage.