What is counterparty risk?
When an agreement’s made, counterparty risk refers to the threat of the other party not meeting its financial obligations. Counterparty risk is sometimes also called default risk and credit risk, and is a threat to all parties in a contractual agreement.
Where have you heard about counterparty risk?
Counterparty risk exists to some degree in all financial transactions and is experienced by lenders and investors across the financial industry.
When you purchase stocks and bonds, for example, you’re exposed to counterparty risk. If the counterparty risk is thought to be low, insurance rates and premiums are also low.
However, it’s not uncommon for investors to purchase products with a higher counterparty risk in the hope of securing a higher return on their investment.
What you need to know about counterparty risk.
Depending on the nature of the agreement you may want to reduce your risk from the outset. This can be done in several ways such as including risk-based pricing and penalty agreements in the contract, or requesting that collateral is provided as part of the terms.
A third-party guarantor with good credit can act as an mediator between parties and underwrite any debts.