Financial derivatives are contracts derived/created from an underlying asset or group of assets (such as stocks, bonds, commodities, currencies, interest rates, and market indexes) between 2 or more parties. The value of the derivative is a function of the value of the underlying assets (mainly). Derivatives are securities, traded through exchanges or over-the-counter (OTC).
Common derivatives include:
Hedges are accomplished through derivatives, which are used to both make speculative investments or mitigate unwanted risk by locking in a price for the participants of the contract. Currency risk can be mitigated through currency futures, for example. This is useful if you’re based in Australia and have decided to invest in overseas markets like the U.S. If the AUD were to appreciate against the USD, then your returns from the U.S. markets would be less valuable after being converted back to AUD. Speculators believing the AUD to depreciate against the USD can hold derivatives and benefit from the AUD depreciating, without actually holding the underlying asset.