Wednesday, December 29, 2010

Counterparty Risk

Counterparty Risk is the risk of the counterparty to a financial instrument or contract defaulting or failing to settle. Counterparty risk is most poignant in over the counter trading of derivatives e.g. credit default swaps, swaps, forward contracts, insurance contracts, and other trades. Counterparty risk is somewhat alleviated when trading is cleared through a central counter party e.g. as in exchange traded derivatives which are cleared and novated through the clearing house. ETFs, ETNs and other managed funds may have counterparty risk exposure through the use of derivatives. Counterparty risk was recently highlighted during the global financial crisis when a significant investment bank, Lehman Brothers, fell over.

Synonyms: Settlement risk, Herstatt Risk

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