A financial instrument that is embedded with certain types of derivatives (embedded derivatives). The instrument plays host to the embedded derivatives, and usually comes in two key forms: debt host and equity host (host contract). An example is a 3-year certificate of deposit (CD) issued by a bank. The holder would receive its par value in addition to a return linked a reference rate (e.g., stock index). In this case, the host contract (i.e., the certificate of deposit) comes with an embedded derivative (an option on the index).

Depending on the connection between the host contract and the embedded derivative, accounting treatment would differ. If the embedded derivative is not closely related to the host debt instrument, in terms of the economic characteristics of each, then the issuer would be required to separate the two (by way of bifurcation). As a result of this bifurcation (bifurcating/ separating the derivative from its host contract), the bank, in the above example, must account for the certificate of deposit separately from the embedded index option. In practice, the bifurcated embedded derivative is typically marked to market each accounting period, as a derivative, not as part of the host contract. Likewise, the host contract must be accounted for separately from the derivative (depending on the respective treatment of such a contract).