Updated on March 1, 2023
The term counterparty refers to a person or an entity that is part of an agreement or a contract. The simplest explanation to a counterparty can be explained as a buyer to a seller and vice versa or a borrower to a lender and so on. A counterparty may not necessarily have equal rights or obligations in a contract and may also not be the same class of entities as companies, individuals, government bodies, etc.
The term counterparty also gives rise to counterparty risk. This is the risk of non-adherence to the terms of the contract or agreement by either party. The most common type of counterparty risk is the default risk. To mitigate this type of risk, parties often add the counterparty risk premium to the terms of contract and safeguard their interests.