Defining Counterparty Risk

Defining Counterparty Risk - Defining Counterparty Risk...

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Defining Counterparty Risk Counterparty risk is the risk to each party of a contract that the counterparty will not live up to its contractual obligations ; it is otherwise known as default risk . Counterparty risk relates closely to performance risk. It arises whenever one entity depends on another to honor the terms of a contract. If a parts supplier fails to provide steering wheels to General Motors, GM will be damaged because of its inability to deliver complete cars. The resulting profit reduction is defined as the exposure that GM runs to its supplier. Similarly, GM runs a credit exposure to its customers who have not yet paid for their cars. This would include dealers and end customers who are financed by GMAC, GM’s financing subsidiary. Normally, performance risk is managed operationally—i.e., GM would use alternative suppliers, reserve supplies of steering wheels, and contractual nonperformance remedies to manage its performance risk. Also, to manage risk to its dealers, it may
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This note was uploaded on 03/07/2012 for the course FINANCE 280 taught by Professor Saira during the Spring '12 term at IMSciences.

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Defining Counterparty Risk - Defining Counterparty Risk...

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