You're walking through wolf-infested woods with a large package of raw meat in your backpack. You start to get a little nervous, so you move the meat to someone else's pack. Transfer of risk.
The financial version of the term works much the same way. The goal is to move the consequence of an unfavorable event onto someone else. Something goes wrong, but you don't have to pay for it. Someone else does. That situation defines a transfer of risk.
The most obvious example involves insurance. When you get an insurance policy, you're effectively conducting a transfer of risk. Now, if your car gets wrecked in an accident, or your house gets wrecked by a coordinated beaver attack, you don't have to pay to get it repaired. The insurance company does.
Insurance companies pull this maneuver as well. They don't just sit on all the risk they have. They look to transfer it. So insurance firms enter into reinsurance contracts with other companies, transferring a portion of their risk onto another firm.
Related or Semi-related Video
Finance: What is Counterparty Risk?9 Views
Finance a la shmoop what is counterparty risk?
alright here's you the party and here's the guy you're contracting with to sell [Woman and man stood side by side]
18 tons of bricks or buy a line of credit for your flower shop or sell a
futures contract with the right to buy oil at 80 bucks a barrel for the next [Person signs contract]
two years so you're the party and he's the counterparty and the yin and yang of
the party and here's the risk yeah well the counterparty risk is just
that the person you contracted with doesn't live up to their end of the
bargain you pay them good money you sign a good contract all lawyered up and [Stack of money and contract appears]
stuff and then they split like totally split disappeared sea men choose the
bottom of the ocean maybe they went to Bora Bora
maybe they got facial surgery in the Philippines you know they do that now [George Clooney in a surgical bed]
well when that happens you will probably feel like crying and you should its your
counterparty you can cry if you want to come on that was a good reference people [Man singing]
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