What are derivatives primarily used for in finance?

Derivatives are primarily used in finance to hedge against or speculate on the price movements of underlying assets. This is because derivatives derive their value from the performance of an underlying asset, which can include stocks, bonds, commodities, or interest rates. Investors and companies utilize derivatives to manage risk associated with price fluctuations. For example, investors may hedge their exposure to adverse price movements by entering into derivative contracts such as options or futures, which provide a way to lock in prices or protect against losses.

Additionally, speculation involves taking on risk with the expectation that the price of the underlying asset will move in a favorable direction. Traders may use derivatives to gain exposure to potential price movements without needing to actually own the underlying asset, allowing for greater leverage and the potential for significant profits (or losses) based on market movements.

While generating fixed income and simplifying regulatory compliance can be important functions of other financial instruments, they do not capture the core uses of derivatives. Similarly, while diversification across asset classes is a common investment strategy, derivatives themselves do not inherently provide diversification; rather, they are tools that can be employed as part of a broader strategy to hedge or speculate. This focus on hedging and speculation highlights why option B is the most accurate representation of the primary uses of derivatives