Counterparty Risk
The risk that the other party to a contract fails to perform its obligations.
How it is identified
Test: performance of the contract depends on a specific party's solvency, with no guarantor standing behind it
Unit
qualitative
In depth
Exchange-traded instruments largely remove this risk through novation, where the clearing corporation becomes counterparty to both sides — which is why an anonymous trade with a stranger is safe. Over-the-counter contracts such as forwards and bilateral swaps carry it in full, and it is managed through collateral, netting agreements and credit limits. For a retail investor the practical residue is broker risk, which is why securities held in one's own demat account are safer than balances left with a broker. The 2008 crisis was in large part a counterparty risk event, which is why regulators pushed derivatives toward central clearing.
Worked example
A bilateral forward with a bank leaves you exposed to that bank until settlement. The equivalent exchange-traded futures position leaves you exposed only to the clearing corporation, which holds margin from every participant.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Counterparty Risk” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.