What is meant by 'credit risk' in trading?

What is meant by 'credit risk' in trading?

• A. The risk of price fluctuations
• B. The risk of a counterparty defaulting on obligations
• C. The risk associated with interest rate changes
• D. The risk of losing market access

Answer: (B)

Credit risk refers to the potential that a counterparty in a financial transaction may default on their obligations, such as failing to make timely payments or not fulfilling contractual commitments. In trading, this risk is particularly pertinent in transactions involving derivatives, bonds, or any agreements where one party relies on another to meet their financial responsibilities. If a counterparty defaults, it could lead to significant financial losses for the other party involved in the trade. Understanding credit risk is essential for traders and investors because it influences decision-making regarding whom to engage in transactions with, how much exposure to accept, and what measures to take to mitigate potential losses. This can include assessing the creditworthiness of counterparties through credit ratings or implementing collateral agreements to secure obligations. While the other options address important risks associated with trading, such as price fluctuations (which relate to market risk), interest rate changes (which pertain to interest rate risk), and losing market access (which refers to liquidity risk), none of these directly capture the essence of credit risk as it pertains to counterparty default.

Credit risk refers to the potential that a counterparty in a financial transaction may default on their obligations, such as failing to make timely payments or not fulfilling contractual commitments. In trading, this risk is particularly pertinent in transactions involving derivatives, bonds, or any agreements where one party relies on another to meet their financial responsibilities. If a counterparty defaults, it could lead to significant financial losses for the other party involved in the trade.

Understanding credit risk is essential for traders and investors because it influences decision-making regarding whom to engage in transactions with, how much exposure to accept, and what measures to take to mitigate potential losses. This can include assessing the creditworthiness of counterparties through credit ratings or implementing collateral agreements to secure obligations.

While the other options address important risks associated with trading, such as price fluctuations (which relate to market risk), interest rate changes (which pertain to interest rate risk), and losing market access (which refers to liquidity risk), none of these directly capture the essence of credit risk as it pertains to counterparty default.