Editing Derivative (finance) (section)

==Basics==
{{more citations needed| section|date=July 2023}}

Derivatives are contracts between two parties that specify conditions (especially the dates, resulting values and definitions of the underlying variables, the parties' contractual obligations, and the [[notional amount]]) under which payments are to be made between the parties.<ref name="hull"/><ref>{{cite book |last=[[Mark Rubinstein]] |title=Rubinstein on Derivatives |publisher=Risk Books |year=1999 |isbn=978-1-899332-53-3}}</ref> The [[assets]] include [[Commodity|commodities]], [[stock]]s, [[bond (finance)|bond]]s, [[interest rates]] and [[currencies]], but they can also be other derivatives, which adds another layer of complexity to proper valuation. The components of a firm's [[capital structure]], e.g., bonds and stock, can also be considered derivatives, more precisely options, with the underlying being the firm's assets, but this is unusual outside of technical contexts.

From the economic point of view, financial derivatives are cash flows that are conditioned [[stochastic]]ally and discounted to present value. The [[market risk]] inherent in the [[underlying asset]] is attached to the financial derivative through contractual agreements and hence can be traded separately.<ref name="ssrn.com">{{cite SSRN|last1=Koehler|first1=Christian|title=The Relationship between the Complexity of Financial Derivatives and Systemic Risk|page=10|ssrn=2511541|date=May 31, 2011}}</ref> The underlying asset does not have to be acquired. Derivatives therefore allow the breakup of ownership and participation in the [[market value]] of an asset. This also provides a considerable amount of freedom regarding the contract design. That contractual freedom allows derivative designers to modify the participation in the performance of the underlying asset almost arbitrarily. Thus, the participation in the market value of the underlying can be effectively weaker, stronger (leverage effect), or implemented as inverse. Hence, specifically the market price risk of the underlying asset can be controlled in almost every situation.<ref name="ssrn.com"/>

There are two groups of derivative contracts: the privately traded [[over-the-counter (finance)|over-the-counter]] (OTC) derivatives such as [[swap (finance)|swaps]] that do not go through an exchange or other intermediary, and [[Exchange-traded derivative contract|exchange-traded derivatives]] (ETD) that are traded through specialized [[derivatives exchange]]s or other exchanges.

Derivatives are more common in the modern era, but their origins trace back several centuries. One of the oldest derivatives is rice futures, which have been traded on the [[Dojima Rice Exchange]] since the eighteenth century.<ref name="Rice_FT">{{cite news
| url = http://www.ft.com/cms/s/0/d9f45d80-6922-11da-bd30-0000779e2340.html
| date = December 10, 2005
| title = Sensitive politics over Japan's staple crop delays rice futures plan
|author1=Kaori Suzuki |author2=David Turner | work = [[The Financial Times]].
| access-date = October 23, 2010
}}</ref> Derivatives are broadly categorized by the relationship between the underlying asset and the derivative (such as [[forward contract|forward]], [[option (finance)|option]], [[swap (finance)|swap]]); the type of underlying asset (such as [[equity derivative]]s, [[foreign exchange derivative]]s, [[interest rate derivative]]s, [[commodity derivative]]s, or [[credit derivative]]s); the market in which they trade (such as exchange-traded or [[over-the-counter (finance)|over-the-counter]]); and their pay-off profile.

Derivatives may broadly be categorized as "lock" or "option" products. Lock products (such as [[swap (finance)|swap]]s, [[futures contract|futures]], or [[Forward contract|forwards]]) obligate the contractual parties to the terms over the life of the contract. [[Option (finance)|Option]] products (such as [[interest rate swaps]]) provide the buyer the right, but not the obligation to enter the contract under the terms specified.

Derivatives can be used either for risk management (i.e. to "[[Hedge (finance)|hedge]]" by providing offsetting compensation in case of an undesired event, a kind of "insurance") or for speculation (i.e. making a financial "bet"). This distinction is important because the former is a prudent aspect of operations and financial management for many firms across many industries; the latter offers managers and investors a risky opportunity to increase profit, which may not be properly disclosed to stakeholders.

Along with many other financial products and services, derivatives reform is an element of the [[Dodd–Frank Wall Street Reform and Consumer Protection Act]] of 2010. The Act delegated many rule-making details of regulatory oversight to the [[Commodity Futures Trading Commission]] (CFTC) and those details are not finalized nor fully implemented as of late 2012.