What is the main characteristic of a financial derivative?

The main characteristic of a financial derivative is that it derives its value from underlying assets. This means that the worth of a derivative financial instrument is linked to the price movements of other assets, such as stocks, bonds, commodities, or currencies. Derivatives are often used for hedging risk or speculation, as they can provide investors with the ability to make bets on the future price of an asset without having to own the asset itself.

The concept of underlying assets is crucial in understanding how derivatives function, as their value fluctuates based on the performance of these assets. This relationship can result in significant financial leverage, allowing for potentially large gains or losses depending on market movements. When analyzing derivatives, recognizing this connection to other financial instruments is essential for comprehending their role in financial markets.