| Definition |
A financial contract whose value is derived from the performance of an underlying asset, index, or rate. |
An agreement to buy or sell an asset immediately at the current market price. |
| Underlying Asset |
Can be stocks, commodities, currencies, interest rates, indices, etc. |
Physical asset or financial instrument like commodities, stocks, or currencies. |
| Settlement Date |
Settled at a future date specified in the contract. |
Settlement occurs immediately or within 2 business days. |
| Purpose |
Used for hedging, speculation, arbitrage, and risk management. |
Used for immediate delivery or possession of the asset. |
| Price Determination |
Price is agreed upon at the contract inception but delivery happens later. |
Price is the current market price, called the spot price. |
| Leverage |
High leverage is common, requiring only margin or a small initial investment. |
No leverage; full payment required upfront for the asset. |
| Risk |
Risk includes market risk, counterparty risk, and liquidity risk. |
Risk is primarily market risk due to price fluctuations. |
| Types |
Includes futures, options, forwards, swaps, etc. |
Single type – immediate purchase or sale of asset. |
| Delivery |
Can be physical delivery or cash settlement depending on contract terms. |
Physical delivery or transfer occurs immediately. |
| Regulation |
Heavily regulated due to complexity and risk; traded on exchanges or OTC. |
Less regulated; occurs on exchanges or OTC markets. |
| Liquidity |
Liquidity depends on the type and market; some derivatives are less liquid. |
Generally highly liquid as it involves actual assets. |
| Margin Requirement |
Margin is required to enter and maintain positions. |
No margin; full payment upfront is needed. |
| Market Participants |
Includes hedgers, speculators, arbitrageurs, and institutions. |
Includes buyers and sellers needing immediate possession. |
| Accounting Treatment |
Complex accounting with mark-to-market adjustments. |
Simpler accounting; asset recorded at purchase price. |
| Examples |
Gold futures, stock options, currency swaps. |
Buying gold bars, buying shares in the stock market for immediate settlement. |
| Profit/Loss Realization |
Profit or loss realized upon contract expiry or sale before expiry. |
Profit or loss realized immediately upon transaction. |
| Flexibility |
Highly customizable contracts (especially OTC derivatives). |
Standardized and straightforward transaction. |
| Impact of Price Movements |
Can be magnified due to leverage. |
Directly reflects actual asset value change. |
| Use in Risk Management |
Widely used to hedge against price fluctuations in underlying assets. |
Limited use in risk management; more for immediate needs. |
Derivative Contract vs Spot Contract