Derivative instrument, or only derivative, is a kind of financial instrument. As the name suggests, the value of a derivative is derived from the value of the underlying asset. The value by using which a derivative instrument calculates its value is termed as underlier.
• Examples:
• It can be explained with an example, say, and stock option. The value of the stock option is derived from the stock value; therefore a stock option can be a derivative.
• Another good example of derivative instrument is the interest rate swap, for it calculates its value using the interest rate indices.
• Classification:
• Derivative instruments can be classified through several ways. One is the difference between non-linear derivatives and linear derivatives.
The non-linear derivatives have non-linear payoffs whereas; the linear derivatives have linear payoffs. Non-linearity occurs in case of an option.
• Another two types of derivatives are exotic derivatives, which are complicated, and vanilla derivatives, which is very common.