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A Derivative Security is an investment like an options or futures contract that 'derives' it's value from another asset such as a stock, bond or currency.
Likely the simpleist example of a Derivative Security is a call option on a stock. With a call option, the buyer has the right to buy a stock at a specified 'strike-price' for a period of time. The seller is obligated to sell at that price. If the stock price does not move in favor of the buyer by the expiration date then the option expires worthless and the buyer has lost the premium paid. As a result the payoff of a derivative like an options contract is not linear.
Synonym: financial derivatives
For context, derivative securities are commonly used at institutional firms and banks as a risk management tool. So firms use derivatives to offset the risk of future changes in the price of commodities, equities, interest rates and currencies.
Kay: Couldn't your client use a derivative
security to protect him from downside risk?
Jim: Yes, but I'd have to explain it so he understands it. That's the downside.
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