A financial derivative is a financial instrument where the price is derived from the value of an underlying asset often used to manage risk exposure. There are three classes of derivatives.
Futures: A futures contract is a “commitment to exchange a specified amount of one asset for a specified amount of another asset at a specified time in the future” (Butler, 2003).
Options: An options contract “gives the option holder the right to buy or sell an underlying asset at a specified price and on a specified date” (Butler, 2003).
Swaps: A swap is an “agreement to exchange two liabilities (or assets) and, after a prearranged length of time, to re-exchange the liabilities (or assets)” (Butler, 2003).
Financial derivatives are a very complex system of agreements. It is wise to consult a banking professional for advice on how to implement.
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