What are derivatives in the context of financial markets?

Derivatives are financial instruments whose value is derived from an underlying asset, index, or rate. This means that the price of a derivative reflects the price movements of the asset to which it is linked, such as stocks, bonds, commodities, or interest rates. Derivatives can take various forms, including options, futures, and swaps, and are commonly used for hedging risk or for speculative purposes.

For instance, a futures contract on oil allows investors to lock in a price for oil at a future date, which can protect against price fluctuations. Thus, the correct understanding of derivatives focuses on their dependence on other assets, which is accurately captured in the definition of financial contracts linked to the price of an underlying asset.

The other options describe different concepts in finance. Assets that can be easily converted into cash refer to liquidity, not derivatives. Stock shares are equity securities representing ownership in a company, while investments in government bonds denote fixed-income securities, both of which are distinct from the nature of derivatives. Understanding this distinction is essential for grasping the role of derivatives in financial markets.