Catastrophe bonds, or cat bonds, are financial instruments used by insurance companies and governments to transfer the risk of natural disasters, like hurricanes or earthquakes, to investors. When a disaster occurs, the bond's principal is used to cover the losses, helping the issuer manage financial strain. Investors buy these bonds for higher returns, which compensate for the risk of losing their investment if a catastrophe happens. If no disaster occurs during the bond's term, investors receive their principal back along with interest. This mechanism helps provide immediate funds for recovery efforts after a disaster.