What Is a Derivative Contract?

What Is a Derivative Contract?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A derivative contract is a financial agreement that relies on an underlying asset for its value. These contracts are used in financial markets for various purposes like hedging risks, gaining access to inaccessible markets, or leveraging positions in the market. Different types of derivative contracts include futures, options, forwards, and swaps. Here are five more questions related to this topic.

Related Questions

1. What is a Futures Contract?

A Futures Contract is a type of derivative where two parties agree to buy or sell a particular asset at a pre-determined price in the future. This contract standardizes the quantity and quality of the asset to be traded.

2. What is an Options Contract?

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An Options Contract is another type of derivative where the buyer gets the right, but not the obligation, to buy or sell an asset, at a set price, on or before a certain date. There are two types of options contracts – Call options (right to buy) and Put options (right to sell).

3. How is a Forward Contract different from a Futures Contract?

A Forward Contract is a private and customizable agreement between two parties to trade an asset at a future date. Unlike Futures Contracts, Forward Contracts are not traded on a centralized exchange and are generally not standardized.

4. What is a Swap?

A Swap is a derivative contract through which two parties exchange the cash flows or liabilities from two different financial instruments. The most common example is the interest rate swaps.

5. Why are Derivative Contracts used?

Derivative Contracts are used to hedge risks, speculate on future prices of the underlying asset, gain access to otherwise inaccessible markets, or increase leverage in the market.