Derivative

 A derivative is a financial contract between two parties that derives its value from an underlying asset. The value of the derivative is dependent on the performance of the underlying asset, such as its price, interest rate, or exchange rate

Imagine a letter or piece of paper. You know what the value of a piece of paper is, right? It is the value of a piece of paper, which is equal to the value of a piece of paper. You know the value of assets is influenced by market conditions, so if there is a contract based on those underlying assets, that would be Financial Derivatives. Please note that the value of contracts is based on the underlying value of those assets plus the value of that contract.

Now we talk about how derivatives work.

There is Vivek, who wants 5000 Kg oranges today, so he has to buy the oranges at 1 USD a kg today, what if, he wants to buy 5000 Kg in the future, let's just say 3 months ahead, he wanna pay the price at today’s rate, so he will go to Mr. Patel who will make the contract where Mr Patel will purchase the oranges for the Vivek at the 1 USD a kg regardless of the price, in the exchange Vivek has to pay the charges for the contract to Mr. Patel.

This is the simplest way to explain derivatives, which can be super complex, underlying many contracts with many assets.

As we can see, the prices of oranges can be influenced by multiple factors. Therefore, many call it a risky contract, and some call them “bets.” However, they are simply tools for the transaction.