Definition
Counterparty risk management involves assessing the creditworthiness of trading partners, setting exposure limits, requiring collateral (margin), using netting agreements, and routing trades through central clearinghouses. Credit Valuation Adjustment (CVA) quantifies the market price of counterparty risk. Post-2008 reforms significantly strengthened counterparty risk practices.
lightbulb Example
A bank has $500M notional in OTC derivatives with Counterparty X (rated BBB). Risk management: limits exposure to $50M, requires $10M initial collateral, uses ISDA netting to reduce gross exposure, and charges CVA of $300K.
verified_user Key Points
- Assess creditworthiness before and during trades
- Set exposure limits by counterparty
- Collateral requirements reduce loss given default
- Central clearing eliminates bilateral counterparty risk