Introduction:
Counterparties are those parties that are a part of a monetary transaction. Each transaction will have a counterparty without which the transaction can not go through. For example, a purchaser of an asset will be up against the seller who is looking to sell his asset, the vice verse as well holds good.
For instance, the counterparty for an option purchase will be an option writer. For any completed trades, numerous counterparties can be involved. For instance, in order to purchase 1,000 shares, a buyer may purchase 100 shares each from ten different sellers.
Understanding Counterparty:
The word counterparty may refer to entities on both sides of a monetary transaction. These transactions may cover deals and agreements made between individuals, governments, businesses, or any other entities.
Besides, both parties will not have to be equal ranks concerning the kind of companies being involved. This translates to mean that an individual may be a counterparty to a company and the other way around as well holds good.
Consider an example where a general agreement is met, one of the parties will be called as the counterparty. This is applicable in the case of future or forward contracts also.
Counterparty Risk:
The introduction of counterparty brings in a risk called counterparty risk. This is the risk or the probability of the counterparty not being able to stand by their obligations. Nevertheless, the counterparties are not known, and the risk involved is handled via the help of clearinghouses and firms in some financial transactions.
As a matter of fact, nobody knows who their counterparty is in most of the trades in a typical exchange trading. More often than not, there will be multiple counterparties who end up being a part of the trade.
