Why this matters
A contract whose value or payments depend on an underlying asset, indicator or event.
Example
A producer seeking to reduce uncertainty about a future raw-material price may use a suitable derivative contract. Futures and options are common examples. A mismatch in volumes, maturities or raw-material characteristics can leave part of the risk in place.
Common mistake
A derivative does not necessarily mean buying the underlying asset. Read the terms for exercise, collateral, possible additional payments and termination. A small initial amount does not mean a small maximum loss. Understand the full pattern of cash obligations and price scenarios rather than relying on the instrument’s name or a promise of high return.