Counterparty Risk

Counterparty risk refers to the chance that the other party in a financial agreement will not fulfill their obligations—often because they go bankrupt or face financial trouble. This type of risk appears in various situations, such as when a lender provides a loan and relies on the borrower to repay, or when two parties enter into contracts or use derivatives. If counterparty risk increases, it can directly reduce the value of contracts and financial instruments, as the possibility grows that promises won’t be kept. Managing counterparty risk is an important part of any financial transaction.