title: Derivative Valuation
Consider a contract
A derivative is a (legal) contract: I will give you this at these times if you will give me that at those times. A buyer specifies what cash flows they would like to receive and a seller specifies what cash flows they require in order to enter the contract. Unlike a bond or a stock, there are no physical assets behind a derivative contract. When a company goes bankrupt you can recover some fraction of their remaining assets if you hold a bond or stock. When one counterparty abrogates their obligation in a derivative contract, the other only holds a piece of paper.
Even in our simple example there are a number of transactions required.