Suppose you run a company that requires 10 million barrels of oil every year. The variability in the oil prices means your company is exposed to some extra risk which you would prefer to avoid. This is where financial derivatives are introduced.
Financial Derivative
A derivative (or financial derivative) is a contract whose value depends on, something else, called the underlying.
The underlying could be any commodity, currency, interest rate etc. For example, if our contract is on oil than the underlying is price of oil.
The most commonly used derivatives are: