Counterparty Risk

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DEFINITION of 'Counterparty Risk'

The risk to each party of a contract that the counterparty will not live up to its contractual obligations. Counterparty risk as a risk to both parties and should be considered when evaluating a contract.

In most financial contracts, counterparty risk is also known as "default risk".

BREAKING DOWN 'Counterparty Risk'

Because A is a counterparty to B and B is a counterparty to A both are exposed to this risk. For example if Joe agrees to lends funds to Mike up to a certain amount, there is an expectation that Joe will provide the cash, and Mike will pay those funds back. There is still the counterparty risk assumed by them both. Mike might default on the loan and not pay Joe back or Joe might stop providing the agreed upon funds.

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