Counterparty Risk

You make a bet with your friend that the Dallas Cowboys will lose by 30 points to the Miami Dolphins, straight up. On Sunday, the Miami Dolphins beat the Cowboys by 57 points, easily covering.

Congrats: You’re up $50.

You take money out of your banking account with a balance of $75 to pay for a hospital bill that has been sitting on your desk. You immediately go to your friend's house. You find that he's boarded up his door, moved out all of his furniture, and disconnected his cell phone. On the door, you see a note: "Blame Jerry Jones." Your friend has skipped out on his obligation…over 50 bucks.

This is an example of counterparty risk. It is the risk that the other person involved in a contract (be it a forward contract, a sales contract, or any other deal) cannot honor or live up to their obligations. This is an essential component of contract law.

It’s vital that individuals do their diligence on anyone with whom they enter into an agreement.