Loading the player...

What is a 'Counterparty'

A counterparty is the other party that participates in a financial transaction, and every transaction must have a counterparty in order for the transaction to go through. More specifically, every buyer of an asset must be paired up with a seller who is willing to sell and vice versa. For example, the counterparty to an option buyer would be an option writer.

Breaking Down 'Counterparty'

A counterparty introduces counterparty risk into the equation. This is the risk that the counterparty will be unable to fulfill their end of the transaction. However, in many financial transactions, the counterparty is unknown and the counterparty risk is mitigated through the use of clearing firms.

The term counterparty can refer to any entity on the other side of a financial transaction. This can include deals between individuals, businesses, governments, or any other organization. Additionally, both parties do not have to be on equal standing in regards to the type of entities involved. This means an individual can be a counterparty to a business and vice versa. In any instances where a general contract is met or an exchange agreement takes place, one party would be considered the counterparty, or the parties are counterparties to each other.

Counterparties in Financial Transactions

In the case of a purchase of goods from a retail store, the buyer and retailer are counterparties in the transaction. In terms of financial markets, the bond seller and bond buyer are counterparties.

In certain situations, multiple counterparties may exist as a transaction progresses. Each exchange of funds, goods or services in order to complete a transaction can be considered as a series of counterparties. For example, if a buyer purchases a retail product online to be shipped to their home, the buyer and retailer are counterparties, as are the buyer and the delivery service.

In a general sense, any time one party supplies funds, or items of value, in exchange for something from a second party, counterparties exist. Counterparties reflect the dual-sided nature of transactions.

Counterparty Risk

In dealings with a counterparty, there is an innate risk that one of the people or entities involved will not fulfill their obligation. Examples of this include the risk that a vendor will not provide a good or service after the payment is processed, or that a buyer will not pay an obligation if the goods are provided first. It can also include the risk that one party will back out of the deal prior to the transaction occurring but after an initial agreement is reached.

For structured markets, such as the stock or futures markets, financial counterparty risk is mitigated by the clearing houses and exchanges. When you buy a stock, you don't need to worry about the financial viability of the person on the other side of the transaction. The clearing house or exchange steps up as the counterparty, guaranteeing the stocks you bought or the funds you expect from a sale.

RELATED TERMS
  1. Replacement Risk

    Replacement risk is a risk that may be present in over the counter ...
  2. Termination Clause

    A termination clause is a section of a swap contract that describes ...
  3. Central Counterparty Clearing House ...

    An organization that exists in various European countries that ...
  4. Option Agreement

    An option agreement is a legal contract between two parties outlining ...
  5. Dollar Roll

    A dollar roll is where two parties agree to buy and sell a similar ...
  6. Termination Date

    A termination date is the day on which a swap contract ends, ...
Related Articles
  1. Trading

    Know Your Counterparty When Day Trading

    This can provide insight into how the market is likely to act based on your presence, orders and transactions.
  2. Tech

    Medici, The Blockchain Stock Exchange

    Overstock CEO Patrick Byrne's revolutionary Project Medici would list Overstock securities on a blockchain-based exchange--a turning point for Bitcoin?
  3. Tech

    The Sharing Economy: Financial Services Will Be Next

    Traditional financial institutions need to adapt to an economy that is rapidly evolving.
  4. Trading

    An Overview Of Futures, Derivatives, and Liquidity

    Gain an understanding of futures and derivatives, and how these instruments are meant to mitigate market risk.
  5. Investing

    An introduction to OIS discounting

    Learn how OIS discounting has become part of standard valuation techniques, particularly in an uncertain, post-recession derivatives market.
  6. Managing Wealth

    An In-Depth Look at the Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  7. Investing

    What's an Interest Rate Swap?

    An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount.
  8. Insights

    Why Are Safe Haven Assets Disappearing?

    The push for safer trading is sharply reducing the supply of safe haven assets, experts say.
  9. Trading

    How to Sell Put Options to Benefit in Any Market

    The sale of a put allows market players to potentially own the underlying security at a future date, at a price below the current market price.
RELATED FAQS
  1. What are some examples of risks associated with financial markets?

    Find out about the different types of risks for different classes of assets including volatility, counterparty risk and default ... Read Answer >>
  2. What is the Federal Reserve Board's market risk capital rule?

    Learn about the market risk capital rule enacted by the Federal Reserve, and understand how this it reflects Basel III international ... Read Answer >>
  3. What factors are the primary drivers of banks' share prices?

    Bank share prices are driven by the same forces as any other shares including market sentiment, expectations about the future ... Read Answer >>
  4. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative. Read Answer >>
Trading Center