What are "financial derivatives"?

Financial derivatives are contracts that derive their value from an underlying financial asset, index, or rate. These instruments are primarily used for hedging risk or for speculative purposes. A derivative’s value changes in response to the price movements of the underlying asset, which can include stocks, bonds, commodities, currencies, or interest rates.

For instance, futures and options are common types of financial derivatives. A futures contract obligates one party to buy and the other to sell an asset at a predetermined future date and price, while an option provides the right, but not the obligation, to buy or sell an asset at a set price before a certain date. The characteristic that defines derivatives is that their existence and value are intrinsically linked to the performance of the asset they are based on.

Understanding derivatives is crucial for participants in banking and finance, as they play a significant role in risk management and financial engineering, allowing individuals or companies to hedge against price fluctuations or to speculate on the future price of an asset. This foundational knowledge is what makes the correct answer stand out in the context of the question.