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What is a derivative?

Derivatives are contracts between a financial reporting company and another party whose overall value is based on an agreed-upon underlying financial asset (e.g. securities) or set of assets. A derivative instrument is a contract that will always be separate from the underlying security.

The most common types of derivatives are call and put options, forward contracts, future contracts, and swaps (interest rate swaps):

As an example, if you purchased a call or put option related to Apple stock, the Apple stock would be the underlying security and the option would be the derivative. The value of the option is only driven by movements in Apple stock.

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