What does a derivative derive its value from?

A derivative is a financial instrument that derives its value from the performance of an underlying asset, index, or benchmark. This underlying entity could be stocks, bonds, commodities, interest rates, currency exchange rates, or other financial assets. The key feature of derivatives is that their value is contingent upon the price movements of these underlying assets.

For instance, options and futures contracts are common types of derivatives, where an option's value is influenced by the price of the underlying stock or commodity it represents. Similarly, futures contracts are agreements to buy or sell an asset at a predetermined price in the future, relying on the anticipated future value of that asset.

Understanding this relationship is crucial for assessing risk and the potential profitability associated with derivatives. This connection to underlying assets distinguishes derivatives from other financial concepts such as government policies, company income, or market demands, which do not define their intrinsic value directly.