Derivative
A derivative is a contract whose value comes from the price, rate or event it references, called the underlying. It lets parties take on or shed exposure to that underlying without buying or selling the underlying itself.
Also called: derivatives · derivative contract · financial derivative · derivative instrument
The underlying can be almost anything with a measurable value: a currency pair, an interest rate, a commodity, a share index, the creditworthiness of a borrower or a crypto asset. Most derivatives are built from four families. A forward fixes a price today for a trade later. A futures contract does the same on an exchange with standard terms. An option gives a right rather than an obligation. A swap, such as an interest rate swap or an FX swap, exchanges one stream of payments for another.
Derivatives trade either on exchanges or over the counter (OTC), negotiated between two parties. The BIS reported the notional value of OTC derivatives outstanding at US$846 trillion at end-June 2025, with interest rate contracts making up 79 percent. Their gross market value, the cost of replacing them all at market prices, was US$21.8 trillion. The gap shows why the notional amount measures the size of what is referenced, not the money at risk.
Because a derivative needs little money upfront relative to its exposure, it carries leverage, and losses are collected in cash through margin calls. A firm can be solvent and still fail if it cannot meet them. The US Financial Crisis Inquiry Commission concluded that OTC derivatives contributed significantly to the 2008 crisis; the reforms that followed pushed standard contracts into central clearing and imposed margin on the rest. For a payments business, the everyday derivative is the FX forward that locks in a conversion rate for a future payout.
In practice
A derivative is neither a hedge nor a bet by nature. The same contract reduces risk when it offsets an existing exposure and adds risk when it does not.
Example
An importer owes a supplier €1 million in three months and agrees a forward to buy euros at 1.10 dollars. The forward is a derivative: its value rises if the euro strengthens and falls if it weakens, offsetting the change in the dollar cost of the invoice.
Learn more on Money Wiki
This page gives the short answer. Money Wiki has a longer guide to Derivative, with more detail and background.
See also
- Forward ContractA forward contract is an agreement to exchange one currency for another on a future date at a rate fixed today. It creates a binding obligation on both sides — which is what makes it useful for certainty and dangerous if the underlying payment never happens.
- Futures ContractA futures contract is a standardised, exchange-traded agreement to buy or sell an asset at a price fixed today, for delivery or cash settlement on a set future date. A clearing house stands between the two sides and collects margin.
- Options ContractAn options contract gives its buyer the right, but not the obligation, to buy (a call) or sell (a put) an asset at a set strike price on or before an expiry date. The buyer pays a premium; the seller, or writer, takes on the obligation.
- Interest Rate SwapAn interest rate swap is a contract in which two parties exchange interest payments calculated on the same notional amount, typically one paying a fixed rate and the other a floating rate, without exchanging the principal itself.
- Notional AmountThe notional amount is the reference size of a derivative contract, the face value on which its payments are calculated. In many derivatives it is never exchanged, and it is not the amount at risk, which is usually a small fraction of it.
- HedgingHedging is taking a position that gains when an existing exposure loses, so that a move in a price, rate or currency leaves the combined result roughly unchanged. A hedge reduces uncertainty; it does not guarantee a profit or rule out a loss.