Everything about Underlying totally explained
In finance, the
underlying of a
derivative is an
asset,
basket of assets,
index, or even another derivative, such that the cash flows of the (former) derivative depend on the value of this underlying. There must be an independent way to observe this value to avoid
conflicts of interest.
For example, in a
stock option to buy 100 shares of
Nokia at EUR 50 in September 2006, the
underlying is a Nokia share. In a
futures contract to buy EUR 10 million 10 year German Government Bonds, the
underlying are the German Government bonds. Other examples are
stock market indexes such as the
Dow Jones Industrial Average and
Nikkei 225.
Fixed-income derivatives are an example of derivatives whose underlying is also a derivative. For example, Euro-Bund options (OGBL) are traded on
Eurex and their underlying is the Euro-Bund futures contract (FGBL).
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