Our first Talk To Me Like I'm Stupid thread turned out really well. There are some great answers in there. To highlight a few really knowledgeable one's, I thought Sf45, Cynic, and Pacal-Emmanuel Gobry offered some really helpful answers. But my favorite came from Darius Tahir. I thought the following should be the first thing out of anyone's mouth whenever someone says, "What the hell is a derivative?"
A while back me and my buddies were playing poker. I got to the game late so there wasn't a spot for me (the game was capped at eight people). So one of the players was playing absolutely awful and losing a ton of cash. I turn to another guy who wasn't playing and said, I bet he'll be the first out. So we made a bet on it (mostly for sport).So, if poker were finance, here's how it would be: the poker players are investing straightforwardly in stocks and bonds and what have you. They're investing in an asset directly. I'm investing in a derivative: my bet is derived from the standing of someone else.