What is Counterparty Risk?
Counterpart risk is one of the most critical risks faced by organizations. It is defined as the risk that a counterparty is unable or unwilling to live up to its contractual obligations which are also referred to as counterparty defaults. Within the context of derivatives contracts, default occurs at some point after inception but prior to the end of the contract term. In case of a default, current and future payments required by the contract will not be made.
Example of Counterparty Risk?
The core operations of a Bank involves lending out money to governments, corporates and individuals. When the Bank lends out money, there is always a possibility the debtor gets default and doesn’t return the money. Here, the risk of not getting the money back is an example of Risk in a financial term.