What are “derivatives”?

A: A derivative is a financial instrument which derives its value from some other financial
price. This “other financial price” is called the underlying.
A wheat farmer may wish to contract to sell his harvest at a future date to eliminate
the risk of a change in prices by that date. The price for such a contract would obviously
depend upon the current spot price of wheat. Such a transaction could take place on a
wheat forward market. Here, the wheat forward is the “derivative” and wheat on the
spot market is “the underlying”. The terms “derivative contract”, “derivative product”, or
“derivative” are used interchangeably.
The most important derivatives are futures and options.