BAFT Certificate in Principles of Payments (CertPAY) Practice Test

Herstatt risk specifically refers to the risk of loss in foreign exchange trading that arises when a party fails to settle a transaction. This situation often occurs in different time zones where one party completes their side of the transaction while the other party, due to a failure to settle, does not receive their currency.

This risk is prominently named after the Herstatt Bank, which failed in 1974 during a foreign exchange settlement, leading to the loss of funds for counterparties who had already paid while not receiving their due currency in return. Thus, Herstatt risk underscores the importance of ensuring that both sides of the transaction are completed simultaneously to mitigate potential losses from such settlement failures.

The other choices, while related to transaction risks in some contexts, do not capture the specific nature of Herstatt risk, which is tied directly to the unique challenges of foreign exchange settlement processes.