In finance, a derivative is a special type of contract. In it, the two parties agree to sell (or to buy) certain goods, at a given price, on a given date. Derivatives can be used in two ways. The first is called speculation: One party hopes that the market price differs from the price agreed upon in the contract, so that he can make the difference between the two. The second is called hedging: One party wants to make sure that the market price doesn't go in a direction that would hurt his profits, so he make sure that the price is agreed upon a long time before the transaction takes place. For a seller, hedging means that he can be certain to receive the agreed upon price, and for the buyer hedging means that he can be certain not to pay more than the agreed upon price. From a moral point of view, speculation is considered a negative activity.
One of the oldest derivatives is rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century.
Derivatives can take many forms but some of the most common types are Futures, Contracts for Difference and Options. They can also be structured on a range of different assets including Forex, Equities, Commodities and interest rates.
Images for kids
Derivatives traders in the pit at the Chicago Board of Trade in 1993
Total world derivatives from 1998 to 2007 compared to total world wealth in the year 2000