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Counterparty Risk
Definition
In a securities transaction, there are normally two counterparties. Parties to the transaction, such as a swap or option, may bear the counterparty risk at any time depending on the value of the contract, i.e. the party that has a positive value associated with their position is bearing the counterparty risk (often called credit risk and default risk as well).
Using the term Counterparty Risk :
Mrs. MacGruber, a massive trader in options, is in the money on her Exxon options. She is bearing the counterparty risk that the derivatives dealer will default on their obligation to honor the option upon exercise.
Pay Special Attention To :
Counterparty risk is a very big deal in financial transaction. Never underestimate this risk and do not take anything for granted. In the financial "crisis" circa 2008, the federal government stepped in to save firms like AIG and arranged sales of comapnies like Bear Stearns primarily due to the massive defaults on securities that may have occured due to the counterparty going bankrupt. When Lehman Brothers was allowed to fail, there was massive uncertainty in the markets due to counterparty risk.
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Related terms
swaps , options , derivatives , accreting swap
