a. What is the actuarially fair cost of full insurance against the loss if the company does not make the investment? b. What is the minimum deductible of an insurance against the loss that would lead the firm to make the investment? c. What is the actuarially fair price of an insurance policy with the deductible in part (b) if the firm makes the investment?
a. What is the actuarially fair cost of full insurance against the loss if the company does not make the investment? b. What is the minimum deductible of an insurance against the loss that would lead the firm to make the investment? c. What is the actuarially fair price of an insurance policy with the deductible in part (b) if the firm makes the investment?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:D3. Firm Risky faces a 12% chance of losing £15 million next year. With an investment of
£220.000, the firm can reduce the probability of this loss to 5%. The risk-free rate is 4%.
a. What is the actuarially fair cost of full insurance against the loss if the company does
not make the investment?
b. What is the minimum deductible of an insurance against the loss that would lead the
firm to make the investment?
c. What is the actuarially fair price of an insurance policy with the deductible in part (b) if
the firm makes the investment?
Expert Solution
Step 1
The question belongs to decision making where there are two options for mitigate future loss.
The two options are, whether to take investment option to mitigate probable loss or to stick with insurance option.
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