What is a negotiable security and how are they related to derivatives?
"As Dheer pointed out, Wikipedia has a good definition of what a negotiable instrument is.  A security is an instrument or certificate that signifies an ownership interest in something tangible. 1 share of IBM represents some small fraction of a company. You always have the ability to choose a price you are willing to pay -- which may or may not be the price that you get. A derivative is a level of abstraction linked by a contract to a security... if you purchase a ""Put"" contract on IBM stock, you have a contractural right to sell IBM shares at a specific price on a specific date. When you ""own"" a derivative, you own a contract -- not the actual security." The price for securities is negotiable.  You totally have a right to make a lower offer when buying or ask for a higher price when selling.    Securities don't trade at a fixed price, the price goes up and down throughout the day based on the price offers made by buyers and sellers and where they find agreement. If a stock last traded for $10, someone can put out an offer to buy the stock at $9.50, if they find someone who wants to sell and will accept that price, then a deal is made. unless something is falling rapidly in price however, an offer that far below the last price is not terribly likely to be accepted. Now if you want to be assured of making a sale or purchase, you generally trade 'at the market' and for small time players that is very much encouraged as it makes it easier for everyone. "negotiability is a legal concept that permits free transfer of a security without the requirement of prior consent of the issuer.  that means the issuer must pay the current holder of the security, irrespective of who he is.  negotiability also protects a good faith buyer of the instrument from adverse ownership claims of purported prior holders of the instrument.  it is not related to ""negotiating"" the price or whatnot.  A negotiable security means the current owner does not have to be concerned about acquiring the asset via a bad chain of title b/c he can always assert that he is a ""holder in due course"" defense against such claims, and have absolute security in his ownership right over the asset.  securities and derivatives are different.  securities are transferrable instruments representing a direct claim on the issuer for the value of the security, whether debt or equity ownership.  derivatives are bilateral contracts, which can only be entered into with the consent of both parties, and can only be transferred by such consent.  derivatives represent a claim against the parties of to the derivative that depends on some economic reference which is outside of the financial condition of the two parties to the contract, such as interest rates, FX rates, commodity prices, etc."
Late to the party, but my finance professor put it in simplest terms:  An example of a derivative is a credit default swap. An example of a credit default swap is that if you and your buddy bet on a football game that happens every year, and if the team you picked wins, you get paid by your friend, but you pay him if his team wins.   The credit default swaps were a huge topic during 2008-2009 because people could bet on companies tanking, and also short their stock to help further the bad vibes. There are two basic kinds of derivatives - forward contracts and options.   A forward is an agreement between two parties for one party to buy/sell some asset to the other at a price that they agree upon today at some date in the future. An option is an agreement that gives one party the right, but not the obligation, to buy/sell the asset at some date in the future.  Most derivatives that exist are a combination of these two things. For instance, a futures contract is a standardized forward contract that is traded on an exchange, and a swap is a portfolio (or chain) of forward contracts linked together. American/Bermudan options are just options that allow you to exercise on more than one day. The answer depends on the specific instrument to which you are referring. It is possible to make straight bets that are cash-settled and in which the underlying commodity or instrument will never be bought or sold.  It is also possible to have such a contract be settled in the underlying (if the cash value is appropriate, then the cash settlement can be used to purchase the underlying directly, if necessary).  Physical delivery was predominant until the last few decades.  Most traders, as opposed to hedgers or strategics, are going to prefer cash-settled contracts as opposed to physical delivery. It is possible to make trades with a brokerage firm such that the firm pays if the trader wins the bet.  The firm will typically find parties on the other side to even out this bet and leave itself neutral as to the outcome (plus a small premium it charges each side for the cost of making the market).  The cost charged to one contracting party should be set by the dealer in relation to prices being charged to parties making the opposite, matching bet (in this way, brokers are following market price, while traders are setting it). Financially, options and contracts can be settled for cash or for the underlying, and they can be made directly with the opposite bettor or with a neutral dealer. For futures, you are obligated to puchase the security at $x when the contract expires.  For an option, you have the right or option to do so if it's favorable to you. While the issuer of the security such as a stock or bond not the short is responsible for the credit risk, the issuer and the short of a derivative is one. In all cases, it is more than likely that a trader is owed securities by an agent such as a broker or exchange or clearinghouse. Legally, only the Options Clearing Corporation clears openly traded options.  With stocks and bonds, brokerages can clear with each other if approved. While a trader is expected to fund margin, the legal responsibility is shared by all in the agent chain.  Clearinghouses are liable to exchanges.  Exchanges are liable to members.  Traders are liable to brokerages.  Both ways and so on. Clearinghouses are usually ultimately liable for counterparty risk to the long counterparty, and the short counterparty is ultimately liable to the clearinghouse. Clearinghouses are not responsible for the credit risk of stocks and bonds because the issuers are not short those securities on the exchange, thus no margin is required.  Credit risk for stocks and bonds is mitigated away from the clearing process. caveat: remember that complex derivatives can be very bad for your wealth (even if you FULLY understand them). A security is a class of financial instrument you can trade on the market.  A share of stock is a kind of security, for example, as is a bond. In the case of your mortgage, what happens: You take out a loan for $180k.  The loan has two components. a.  The payment stream (meaning the principal and the interest) from the loan b.  The servicing of the loan, meaning the company who is responsible for accepting payments, giving the resulting income to whomever owns it. Many originating banks, such as my initial lender, do neither of these things - they sell the payment stream to a large bank or consortium (often Fannie Mae) and they also sell the servicing of the loan to another company. The payment stream is the primary value here (the servicing is worth essentially a tip off the top).  The originating bank lends $180k of their own money.  Then they have something that is worth some amount - say $450k total value, $15k per year for 30 years - and they sell it for however much they can get for it.  The actual value of $15k/year for 30 years is somewhere in between - less than $450k more than $180k - since there is risk involved, and the present value is far less.  The originating bank has the benefit of selling that they can then originate more mortgages (and make money off the fees) plus they can reduce their risk exposure. Then a security is created by the bigger bank, where they take a bunch of mortgages of different risk levels and group them together to make something with a very predictable risk quotient.  Very similar to insurance, really, except the other way around.  One mortage will either default or not at some % chance, but it's a one off thing - any good statistician will tell you that you don't do statistics on n=1.  One hundred mortgages, each with some risk level, will very consistently return a particular amount, within a certain error, and thus you have something that people are willing to pay money on the market for. Futures contracts are a member of a larger class of financial assets called derivatives. Derivatives are called such because their payoffs depend on the price of other assets (financial or real). Other kinds of derivatives are call options, put options. Fixed income assets that mimic the behavior of derivatives are callable bonds, puttable bonds etc.  A futures contract is a contract that specifies the following: Just like with any other contract, there are two parties involved. One party commits to delivering the underlying asset to the other party on expiration date in exchange for the futures price. The other party commits to paying the futures price in exchange for the asset. There is no price that any of the two parties pay upfront to engage in the contract. The language used is so that the agent committing to receiving the delivery of the underlying asset is said to have bought the contract. The agent that commits to make the delivery is said to have sold the contract.  So answer your question, buying on June 1 a futures contract at the futures price of $100, with a maturity date on August 1 means you commit to paying $100 for the underlying asset on August 1. You don't have to pay anything upfront. Futures price is simply what the contract prescribes the underlying asset will exchange hands for. The point of derivatives is to get rid of the risk you don't want so you can acquire exposure only to the risk you want. Who wants weather/temperature risk -- speculators. Who doesn't want that risk? Anyone who's core business is adversely affected by bad weather. It's the same reason multinational firms will hedge FX and interest rates. All a speculator is typically doing is taking the other side of the trade based on what they feel is the true price of the risk they are assuming There's someone on both sides of every derivatives trade. When volatility goes up, risk goes up, and prices go up. For every dollar lost when that price changes quickly, someone is making a dollar just as quickly. If you're on the right side, you can make a fortune overnight in derivatives when volatility is high; during a normal market, it is much harder and takes much longer. The most obvious use of a collateral is as a risk buffer. Just as when you borrow money to buy a house and the bank uses the house as a collateral, so when people borrow money to loan financial instruments (or as is more accurate, gain leverage) the lender keeps a percentage of that (or an equivalent instrument) as a collateral. In the event that the borrower falls short of margin requirements, brokers (in most cases) have the right to sell that collateral and mitigate the risk.  Derivatives contracts, like any other financial instrument, come with their risks. And depending on their nature they may sometimes be much more riskier than their underlying instruments. For example, while a common stock's main risk comes from the movements in its price (which may itself result from many other macro/micro-economic factors), an option in that common stock faces risks from those factors plus the volatility of the stock's price.  To cover this risk, lenders apply much higher haircuts when lending against these derivatives. In many cases, depending upon the notional exposure of the derivative, that actual dollar amount of the collateral may be more than the face value or the market value of the derivatives contract. Usually, this collateral is deposited not as the derivatives contract itself but rather as the underlying financial instrument (an equity in case of an option, a bond in case of a CDS, and so on). This allows the lender to offset the risk by executing a trade on that collateral itself. Good comparable.  Interest Rate Swap very often also come at a charge i.e. the hedging counterparty typically charges you a 'credit' and 'execution' charge ontop of what you pay them (fixed rate).  This means that the Mafia-like Bully is going to keep some money in his own pocket for dealing with the 'variable' bully and overall he will take a bit of a profit from this deal. I consider speculation to be a security purchase where the point is to sell it to someone for a higher price.  Day-trading is completely speculative. I consider Investment to be a purchase you make for its underlying value. You are buying it at that price because you believe the present value of the future payments is higher than the price you are paying. I may sell an investment if a higher price is offered than I think it's worth, or if the business situation changes, but I don't plan on it.   Hedging is a third type of security purchase, where you are decreasing your overall risk.  If you are a hog farmer, selling hog futures on the CME is hedging, because it locks in the amount you get per hog, regardless of what the price of hogs does. Commodities markets only have hedgers and speculators.  Investors don't make sense, it doesn't have an underlying value. "How are derivatives like covered warrants or CFDs different from the bucket shops that were made illegal in the US? After reading up a little on the topic, the core difference seems to be that bucket shops were basically running betting pools, with everyone betting against the operator, whereas CFDs and similar derivatives are traded between speculators and the operator merely provides a market and checks the liquidity of participants. A CW seems to be a different matter that I'm not fully sure I understand (at least the description of Wikipedia seems to contradict your statement about not trade being performed on the underlying security). Should I worry that some regulator decides that my ""market maker"" is an illegal gambling operation? Not really. Nations with a mature financial industry (like Japan) invariably have heavy regulations that mandate constant auditing of institutions that sell financial instruments. In Japan, the Financial Services Agency is in charge of this. It's almost impossible that they would let an institution operate and later decide that its basic business model is illegal. What is possible are mainly two scenarios:" "A credit default swap is like insurance on a bond, but it isn't. The cash flows just move similarly. They didn't buy insurance on anything. They just bought a contract.   A put ""is like"" downside insurance on a stock. But of course you can still buy them. Investing in TIPS ""is like"" buying inflation insurance, but it isn't."