Counterparty risk in relation to a life assurance Tracker Bond refers to which risk?

• A. The tax which will be applied to the maturity proceeds will be higher than the applicable rate today.
• B. A third party may default on its obligations to the life company, causing a loss for the investor.
• C. Inflation will erode the real value of the return provided by the bond.
• D. The investor may die before maturity, causing a loss for the investor's dependants.

Answer: (B)

Counterparty risk is the danger that the other party in a financial arrangement won’t meet its obligations. In a life assurance Tracker Bond, the promised payoff or protection often relies on payments or guarantees provided by a third party (a counterparty such as a guarantor or a financial institution). If that counterparty defaults or cannot fulfill its obligations to the life company, the life company may not be able to pass on the expected return to the investor, leading to a loss. Taxes, inflation, and mortality are different kinds of risk and don’t describe the risk that a counterparty will fail to deliver.