Derivative Instrument

From Open Risk Manual


Derivative Instrument. A financial instrument that confers on its holders certain rights or obligations, whose value is derived from one or more underlying assets or entities. having a price that is directly dependent upon or “derived” from the value of one or more underlying instruments


Derivative contracts owe their availability to the existence of markets for an underlying asset or a portfolio of assets on which such agreements are written. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset.

  • Most derivatives are characterized by high leverage.
  • A derivative may be traded on or off an exchange.
  • Derivatives involve the trading of rights or obligations based on an underlying product, but they do not directly transfer underlying property.
  • The derivative is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset.
  • Derivatives can hedge risk or lock-in a fixed rate of return.
  • Derivatives are generally used to hedge risk, but they may be used for speculative pur- poses.


The three major categories of derivative instruments are:

  1. forward and future contracts
  2. options contracts, and
  3. swaps.

The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes.


  • Derivative Contract

IFRS 9 Scope

A financial instrument or other contract with all three of the following characteristics[1].

  • its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the ‘underlying’).
  • it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors.
  • it is settled at a future date.

See Also

  • Hedging
  • Parameswaran, Sunil. Fundamentals of Financial Instruments: An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives. John Wiley and Sons (Asia) Pte. Lte., Singapore, 2011.


  1. IFRS Standard 9, Financial Instruments


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