How are derivatives defined in finance?

Derivatives are defined in finance as financial contracts that derive their value from an underlying asset, index, or security. This means that derivatives do not hold intrinsic value on their own but instead gain their worth based on the performance of the asset to which they are linked. Examples of underlying assets include stocks, bonds, commodities, currencies, and interest rates.

The distinction of derivatives is significant because they are used for various purposes such as hedging risk, speculating on future price movements, or achieving leverage. Since derivatives are inherently tied to these underlying assets, their value can fluctuate in response to movements in the asset's price, making them highly useful in the world of finance.

Understanding that derivatives are essentially contracts helps clarify their role in the financial markets and distinguishes them from tangible assets, equity shares, or cash reserves that have standalone value.