A derivative instrument that is attached to a financial instrument in combination with a host contract. The combination of a host contract (such as a bond, loan, stock, etc) and an embedded derivative (call option, put option, etc) produces a hybrid derivative. The embedded derivative has the effect of modifying the cash flows of a contract based on a pre-defined interest rate, a commodity price, a stock price, an exchange rate, a price index, etc.

If a derivative is added to a host contract but is transferable independently of that contract, or has a different counterparty, it will be treated as a separate derivative rather than an embedded one. Examples of contracts with separate derivatives include credit-linked notes, convertible bonds, equity-indexed notes, commodity-indexed notes, notes with embedded currency options, leverage derivatives, etc.