​Investment - Introduction to Derivatives Contracts 

When you plan a vacation, you do not normally wait until you reach to your chosen destination to book a lodging. Booking a hotel room in advance provides certainty that a room will be available and locks in the price. Your action minimizes uncertainty (risk) for you. It also lowers uncertainty for the hotel.

Now, pretend that you are a wheat farmer and wish to reduce some of the risk of farming. You might presell some of your crop at a fixed price. In fact, contracts to lessen the unpredictability of agricultural products have been dated back to the 16th century. These contracts on agricultural products may be the oldest form of what are known as derivatives contracts or, simply, derivatives.  

Derivatives are contracts that draw their value from the performance of an underlying asset, event, or outcome – hence their name. Since the invention of derivatives contracts to assist minimize risk for farmers, the purposes and varieties of derivatives contracts, and the size of the derivatives market, have risen dramatically. Derivatives are no longer just about lowering risk, but constitute part of the investment plans of many fund managers.