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.
According to the Financial Accounting Standards Board's FASB Statement of Financial Accounting Standards No. 133 (FAS 133) - Accounting for Derivative Instruments and Hedging Activities, an underlying is a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or other variable (including the occurrence or nonoccurrence of a specified event such as a scheduled payment under a contract). An underlying may be a price or rate of an asset or liability but is not the asset or liability itself.
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Famous quotes containing the word underlying:
“The welfare, the happiness, the energy and spirit of the men and women who do the daily work ... is the underlying necessity of all prosperity.... There can be nothing wholesome unless their life is wholesome; there can be no contentment unless they are contented.”
—Woodrow Wilson (1856–1924)
“It is commonplace that a problem stated is well on its way to solution, for statement of the nature of a problem signifies that the underlying quality is being transformed into determinate distinctions of terms and relations or has become an object of articulate thought.”
—John Dewey (1859–1952)
“Every age develops its own peculiar forms of pathology, which express in exaggerated form its underlying character structure.”
—Christopher Lasch (b. 1932)