What is a Derivative Instrument?

A derivative instrument is defined as a financial contract whose value is derived from the performance of an underlying asset, index, or rate. This includes assets such as stocks, bonds, commodities, and interest rates. Derivatives are used for a variety of purposes, including hedging risks associated with price fluctuations and speculating on future price movements.

In the context of the options presented, a contract that derives its fair value from an underlying asset accurately describes derivative instruments as it captures the essence of how their values are determined based on the performance of other assets. This characteristic is fundamental to derivatives, distinguishing them from other financial instruments, which may not have their value contingent on an underlying entity or economic variable.

The other options refer to different types of financial instruments: adjustable-rate bonds relate to fixed-income securities, fixed payment contracts suggest a definitive payout independent of underlying values, and equity securities typically refer to shares of stock, which do not fit the definition of derivatives in the same way that the correct option does. Thus, the choice that highlights contracts based on an underlying asset is the most appropriate definition of a derivative instrument.