Derivatives are financial instruments whose value is derived from an underlying asset. The four main types of derivatives are forwards, futures, options, and swaps.
• Forwards: Agreements to buy or sell a set amount of an asset at a predetermined price in the future.
• Futures: Contracts that obligate the buyer/seller to transact a predetermined quantity/price of an underlying commodity at a specified date in the future.
• Options: Give buyers (holders) rights but not obligations to purchase or sell assets at pre-agreed prices on or before specific dates in the future.
• Swaps: Agreements between two parties where they exchange cash flows over time according to rules determined by contract specifications.
Derivatives have become increasingly popular with investors as these instruments allow them to hedge their risk exposure against adverse market movements while making investments more efficient and liquid.