what is counterparty risk

Counterparty risk is the risk associated with the other party to a financial contract not meeting its obligations. It is the probability that the other party in an investment, credit, or trading transaction may not fulfill its part of the deal and may default. Counterparty risk can exist in credit, investment, and trading transactions. It is a type of credit risk and is the risk of default by the counterparty in many forms of derivative contracts. Counterparty risk exposure is the level of risk facing the company from any one of the counterparties. Counterparty risk exists in many types of transactions and refers to the chance that one party will default on its contractual obligations in the transaction. The numerical value of a borrower’s credit score reflects the level of counterparty risk to the lender or creditor. Counterparty risk is especially relevant to derivatives markets, where notional values can far exceed the size of the underlying securities. To help alleviate this risk, derivatives trades must be cleared via central counterparties, or CCPs, where possible.