What is a derivative?

A derivative is indeed an investment whose value is based on the price of another investment. This characteristic defines derivatives and sets them apart from other financial instruments. Common examples of derivatives include options, futures, and swaps, which derive their value from underlying assets such as stocks, bonds, commodities, or market indexes.

The essence of derivatives lies in their ability to provide a way for investors to hedge against risks or speculate on the future price movements of the underlying assets without necessarily owning those assets directly. This can be particularly useful in managing financial exposure, leveraging positions, and facilitating diverse trading strategies, making derivatives a crucial component of modern financial markets.

In contrast, a type of bond investment, a physical commodity, and a stock option define different financial instruments or assets but do not encompass the broader definition of what derivatives are. They lack the fundamental feature of being linked to the value fluctuating due to another underlying asset's price. Therefore, understanding derivatives as instruments whose value derives from other investments is key to grasping their role in personal financial management and investment strategies.