Table of Contents

Delivery Risk: What it Means, How it Works

By

澳洲幸运5官方开奖结果体彩网:James Chen

Updated October 08, 2022

Reviewed by

Thomas J. Catalano

Fact checked by

Timothy Li

What Is Delivery Risk?

Delivery risk refers to the chance that a counterparty may not fulfill its side of the agreement by failing to deliver the underlying asset or cash value of the contract. Other terms to describe this situation are settlement risk, default risk, and 澳洲幸运5官方开奖结果体彩网:counterparty risk. It'💜s a risk both parties must consider before committing to a financial contract. There are varying degrees of delivery risk that exist in all financial transactions.

Key Takeaways

Delivery risk—also known as settlement or counterparty risk—is the risk that one party won't make good on its end of the agreement.
If one counterparty is considered riskier than the other, then a premium may be attached to the agreement.
Delivery risk, albeit infrequent, rises during times of financial uncertainty.
Most asset managers use collateral, such as cash or bonds, to minimize the downside loss associated with counterparty risk.
Other ways to limit delivery risk include settlement via clearing houses, mark to market, and credit reports.

How Delivery Risk Works

Delivery risk is relatively infrequent but increases during times of global financial strain like during and after the collapse of 澳洲幸运5官方开奖结果体彩网:Lehman Brothers in September 2008. It was one of the largest collapses in financial history and brought mainstream attention back to delivery risk.

Now, most asset managers use collateral to minimize the downside loss associated with counterparty risk. If an institution holds collateral, the damage done when a counterparty goes belly up is limited to the gap between the 澳洲幸运5官方开奖结果体彩网:collateral held and the market price of replacing the deal. Most fund managers demand collateral in cash, 澳洲幸运5官方开奖结果体彩网:sovereign bonds and 🐬even insists on significant margin above the derivative value if they perceive a significant risk𝔉.

Special Considerations

Other measures to mitigate this risk include settlement via 澳洲幸运5官方开奖结果体彩网:clearing house and 澳洲幸运5官方开奖结果体彩网:mark to market (MTM) measures when dealing with over the co๊unt𝔉er trading in bonds and currency markets.

In retail and commercial financial transactions, 澳洲幸运5官方开奖结果体彩网:credit reports are often used to determine the counterparty credit risk for lenders to make auto loans, home loans and business loans to customers. If the borrower has low credit, the creditor charges a higher interest🎃 rate premium due to the risk of default, especially on uncollateralized debt.

If one counterparty is considered riskier than the other, then a premium may be attached to the agreement. In the 澳洲幸运5官方开奖结果体彩网:foreign exchange market, delivery risk is also known as Herstatt risk, named after the small German bank that failed to cover due obligations.

Example of Delivery Risk

Financial Institutions examine many metrics to determine if a counterparty is at an increased risk of 澳洲幸运5官方开奖结果体彩网:defaulting on their payments. They e💟xamine a company's financial statements and employ different ratios to determine the likelihood of repayment.

澳洲幸运5官方开奖结果体彩网:Free cash flow is often us🥂ed to establish the groundwork for whether the company may have trouble generating cash to fulfill their obligations.

A company with negative or shrinking cash flow could indicate higher delivery risk. In the credit market, 澳洲幸运5官方开奖结果体彩网:risk managers consider credit exposur🅰e, expected exposure and future potential exposure to estimate the analogous credit exposure in a credit derivative.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.