A financial derivative is a contract between two parties, where the instrument under trade, derives its value from the price of the underlying asset, hence the name “derivative”.
Derivative means: it is a derived product
For eg. Cheese, butter are derivatives of milk and they derive their value from the pricing of milk. So, if milk prices move higher, it is highly likely that cheese and butter may also get expensive. But would the pace of price increase be at the same pace or at a different one, that’s not a certainty. Derivatives are used as instruments to mitigate price risk through hedged transactions. The history of derivatives dates back centuries and has spanned varied civilisations, dating back to the Mesopotamian era.
The price behaviour of the financial derivative may be linear or non-linear to the price changes of the underlying asset. Examples of derivative contracts include futures, options, forwards, swaps etc. The examples of underlying asset include commodities like metals, agricultural produce, energy and financial assets. Financial assets include equities, bonds and forex. Derivatives may be exchange traded or over the counter (OTC).
The derivatives market in India has witnessed a stupendous growth. Many derivative contracts were also launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are: