Counterparty Risk
Categories: Trading, Banking, Ethics/Morals
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.
Related or Semi-related Video
Finance: What is Counterparty Risk?9 Views
Finance a la shmoop what is counterparty risk?
alright here's you the party and here's the guy you're contracting with to sell [Woman and man stood side by side]
18 tons of bricks or buy a line of credit for your flower shop or sell a
futures contract with the right to buy oil at 80 bucks a barrel for the next [Person signs contract]
two years so you're the party and he's the counterparty and the yin and yang of
the party and here's the risk yeah well the counterparty risk is just
that the person you contracted with doesn't live up to their end of the
bargain you pay them good money you sign a good contract all lawyered up and [Stack of money and contract appears]
stuff and then they split like totally split disappeared sea men choose the
bottom of the ocean maybe they went to Bora Bora
maybe they got facial surgery in the Philippines you know they do that now [George Clooney in a surgical bed]
well when that happens you will probably feel like crying and you should its your
counterparty you can cry if you want to come on that was a good reference people [Man singing]