Explain the Concept of ‘Counterparty Risk’ in Over-The-Counter (OTC) Derivatives

Counterparty risk is the risk that the other party to a financial contract will default on their obligations before the contract expires. This is particularly relevant in OTC derivatives, which are negotiated bilaterally without a central clearing house guarantee.

In the event of a default, the non-defaulting party can suffer a financial loss. This risk is largely eliminated in exchange-traded derivatives.