What does Settlement Risk mean?
Settlement risk is the risk of failure of one party to the contract, to fulfil the terms of the contract at the end of the term; i.e. on settlement. It is the possibility of no payment by the counterparty or no delivery of the security that was agreed upon. It is a type of a default that can lead to principal risk or the risk of losing the principal.
Futures Knowledge Explains Settlement Risk
One of the types of settlement risk is foreign exchange risk or cross-currency settlement risk, For example, Mr. ABC enters into a contract with Mr. XYZ to buy 100 quintals of cotton at $5,000. For Mr. ABC, the settlement risk is that Mr. XYZ won’t deliver the 100 quintals of cotton and the settlement risk for Mr. XYZ is that Mr. ABC won’t pay him $5,000.