What does a derivative's payoff depend on?

The payoff of a derivative fundamentally depends on the performance of specific assets. Derivatives are financial contracts whose value is derived from the underlying asset or group of assets, which can include stocks, bonds, commodities, currencies, or market indices. This means that the profit or loss from a derivative contract is contingent upon the price movement or performance of these underlying assets.

For example, options and futures contracts are common types of derivatives. An option's value will fluctuate based on the price of the underlying asset it is linked to. If the price of that underlying asset moves in a favorable direction, the derivative's payoff increases accordingly. This direct relationship to specific assets is what distinguishes derivatives from other financial instruments.

While fixed interest rates, government policies, and equity market trends can influence market conditions and the performance of underlying assets, they do not directly determine the derivatives' payoffs. Instead, they can be seen as external factors that indirectly affect how specific assets behave, thereby impacting the performance of derivatives. However, the core principle remains that the payoff is inherently tied to the actual performance of the designated underlying assets themselves.