Chap009 - Chapter 9 Risk Aversion and Risk Management by...

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Chapter 9 Risk Aversion and Risk Management by Individuals and Corporations I. Multiple Choice 1. The major underlying force that motivates individuals to purchase insurance even though insurance premiums exceed expected claim costs is: a. profit b. risk aversion c. expected losses d. premium loadings Answer: b Type: K 2. An individual’s demand for insurance depends on all of the following factors except : a. income b. wealth c. premium loading d. portfolio return Answer: d Type: K 3. Suppose that you have $20,000 in wealth and face a 20% chance of losing $10,000. Without insurance, your possible wealth outcomes are: a. $20,000, $18,000 b. $20,000, $10,000 c. $10,000, $2,000 d. $20,000, $18,000 Answer: b Type: A 4. Using the same scenario in Question #3, what is the expected value of your wealth without insurance? a. $20,000 b. $10,000 c. $18,000 d. $16,000 53
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Answer: c Type: A 5. Using the same scenario in Question #3, if you purchase $10,000 in insurance coverage for a price of $2,500, what are your possible wealth outcomes? (Assume that the premium would be paid at the end of the year and that the loss would occur at the end of the year so that you can ignore the time value of money.) a. $20,000, $10,000 b. $17,500 c. $17,500, $7,500 d. $18,000 Answer: b Type: A 6. An example of a non-monetary loss is: a. children’s funeral costs b. damage to your automobile which isn’t covered by your insurance c. pain and suffering d. loss of time at work Answer: c Type: A 7. Suppose that an insurance company views Jennifer as having the following distribution for the present value of losses: Loss = $10,000 with probability .10 $2,000 with probability .20 $500 with probability .50 $0 with probability .20 What is the fair premium for full coverage if the insurer’s competitive loading for administrative costs and capital costs is 10% of expected discounted claims? a. $1,815 b. $1,650 c. $825 d. $165 Answer: a Type: A 54
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8. (Use information from Question #7) If Jennifer believes that her true probabilities for each possible loss outcome are half as high as the insurer has estimated, what is the percentage loading on the policy from her perspective? (Note: This means Jennifer
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This note was uploaded on 10/24/2011 for the course IDS 472 taught by Professor Wang during the Spring '10 term at UChicago.

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Chap009 - Chapter 9 Risk Aversion and Risk Management by...

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