Could you please help me with this question?
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I chose option “C”. Am I correct?
Yes, you are correct… From Reading 42 (pg 307): “The principal device through which risk shifting is performed is a derivative.”
But I thought its option B - If you go with the derivatives section - The use of derivatives facilates the transfer of Risk.
Can you explain me the difference between Risk transfer and Risk shifting.
I think from what it is stated in the question:
Using derivative instruments to change the distribution of risk outcomes is most likely a form of:
The keyword is distribution. Think of the bell curve (with y-axis being the probability)…is the payoff going to be -$100? -150? 0? 200?. By using derivative instrument, you can “shift” the curve.
Risk transfer would be transfer of risk ownership (ie. buying an insurance of a house will “transfer” the risk of flood from homeowner to the insurance company).
Hope this helps
I think of the distinction as (i) redirecting the bullet to someone else, like to an insurer (risk transfer) and (ii) breaking the bullet into 100 pieces, some or all of which may still hit you (risk shifting).
OK… Not a perfect analogy, but you get the idea.
I understand better the difference between risk transfer and risk shifting.
Thanks for the explanation guys!