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Mid-term test 2- 4099 2009 solution

Mid-term test 2- 4099 2009 solution - FACULTY OF BUSINESS...

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L L A K E H E A D U U N I V E R S I T Y F ACULTY OF B B USINESS A A DMINISTRATION Business 4099 WA PERSONAL FINANCIAL PLANNING MODEL SOLUTION Mid-term Test # 2 K. Hartviksen March 12, 2009 Value (3) 1. Explain the meaning of the following terms as they are used in this course: Beneficiary a person (can be an estate) that is named to receive the death benefits of a life insurance policy or pension plan or other type of insurance policy. Adverse Selection is the observation that those most likely to suffer a peril seek to obtain insurance coverage for that risk. Indemnification is the insurance principle that prevents people from making money at insurance. It simply means that the purpose of insurance is to indemnify the person (ie. Restore that person to the original condition.) (4) 2. Define pure and speculative risk and give an example of each. Pure risk involves only the chance of loss (not gain). Examples include, death, loss of health (morbidity), etc. Speculative risk involves both the chance of loss as well as the chance of gain (investing in stocks or bonds) (2) 3. What financial products have been developed in our society to reduce a person’s exposure to a catatrophic loss caused by exposure to a pure risk? Insurance . Including life insurance, long-term disability insurance, accidental death and dismemberment insurance, property insurance (homeowners, automobile). People alone cannot financially tolerate the catastrophic financial losses associated with pure risks. Most people face these risks so large numbers of people representing the whole of society seek to reduce their exposure to these risks. Further, while it is possible to predict with some accuracy the statistical number of people in a population that will suffer a loss, IT IS NOT POSSIBLE to predict the exact person who will suffer the loss in advance. Because of this fact, people facing these risks are willing to pool their resources to help them recover from these catastrophic losses if they do occur in their lives. (2) 4. Explain the meaning of ‘insupportable risk’ and give an example. Ho and Robinson use these terms when explaining how to evaluate risks. Insupportable risks are ones that the household cannot recover from. These are ones that result in LARGE losses, and it doesn’t matter whether the probability of occurrence is high or low. Of course, how a person might manage these losses may depend on the probability of occurrence. Insupportable losses with low probability of occurrence are usually managed through the purchase of insurance. Insupportable losses with high probability of occurrence may be mitigated through avoidance and separation strategies. Business 4099 – 2009 Page 1 TEST # 2 – MODEL SOLUTION
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Examples of insupportable risks for a household include: Death of the sole income earner Long-term disability of the income earner Destruction of the family home, etc.
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