What are financial derivatives commonly associated with?

Financial derivatives are contracts whose value is derived from the price of underlying assets, such as stocks, bonds, commodities, currencies, or interest rates. This characteristic is fundamental to the nature of derivatives, as their primary purpose is to provide a way to hedge risk or speculate based on the anticipated movement of these underlying assets' prices.

For example, options and futures are common types of derivatives. An option gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price before a specific date. The value of this option fluctuates based on the price movements of the underlying asset. Similarly, futures contracts obligate one party to buy, and another to sell, an asset at a specified future date and price, again linking the value of the contract directly to the price of the asset.

In contrast, ownership of physical assets directly involves possessing tangible items, while financial derivatives do not confer ownership. Standard banking institutions and government-issued securities relate to traditional finance and investment avenues rather than the concept of derivatives, which are more focused on contractual agreements based on market prices. Understanding these distinctions is vital for grasping the role and function of financial derivatives in financial markets.