Question

Your firm imports manufactured goods from China. You are worried that U.S.-China trade negotiations could break down next year, leading to a moratorium on imports. In the event of a moratorium, your firm expects its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% to 10%. An insurance firm has agreed to write a trade insurance policy that will pay $450,000 in the event of an import moratorium. The chance of a moratorium is estimated to be 12%, with a beta of 0.8. Suppose the risk-free interest rate is 5.5% and the expected return of the market is 10.0%. a. What is the actuarially fair premium for this insurance? b. What is the NPV of purchasing this insurance for your firm? What is the source of this gain? a. What is the actuarially fair premium for this insurance? The actuarially fair premium is $?. (Round to the nearest dollar.) b. What is the NPV of purchasing this insurance for your firm? The NPV is $?. (Round to the nearest dollar.) c. What is the source of this gain? (Select the best choice below.) A. There is no actual gain since the insurance will only make the firm whole again. B. The gain arises because the firm pays for the insurance when its tax rate is low, but receives the insurance payment when its tax rate is high. C. The gain arises because the firm is overinsured and, had the loss occurred, the firm would be getting more than the value of the loss. D. The gain arises because the firm pays for the insurance when its tax rate is high, but receives the insurance payment when its tax rate is low.

          Your firm imports manufactured goods from China. You are worried that U.S.-China trade negotiations could break down next year, leading to a moratorium on imports. In the event of a
moratorium, your firm expects its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% to 10%. An insurance firm has agreed to write a
trade insurance policy that will pay $450,000 in the event of an import moratorium. The chance of a moratorium is estimated to be 12%, with a beta of 0.8. Suppose the risk-free
interest rate is 5.5% and the expected return of the market is 10.0%.
a. What is the actuarially fair premium for this insurance?
b. What is the NPV of purchasing this insurance for your firm? What is the source of this gain?
a. What is the actuarially fair premium for this insurance?
The actuarially fair premium is $?. (Round to the nearest dollar.)
b. What is the NPV of purchasing this insurance for your firm?
The NPV is $?. (Round to the nearest dollar.)
c. What is the source of this gain? (Select the best choice below.)
A. There is no actual gain since the insurance will only make the firm whole again.
B. The gain arises because the firm pays for the insurance when its tax rate is low, but receives the insurance payment when its tax rate is high.
C. The gain arises because the firm is overinsured and, had the loss occurred, the firm would be getting more than the value of the loss.
D. The gain arises because the firm pays for the insurance when its tax rate is high, but receives the insurance payment when its tax rate is low.

Your firm imports manufactured goods from China. You are worried that U.S.-China trade negotiations could break down next year, leading to a moratorium on imports. In the event of a
moratorium, your firm expects its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% to 10%. An insurance firm has agreed to write a
trade insurance policy that will pay 450,000 in the event of an import moratorium. The chance of a moratorium is estimated to be 12%, with a beta of 0.8. Suppose the risk-free
interest rate is 5.5% and the expected return of the market is 10.0%.
a. What is the actuarially fair premium for this insurance?
b. What is the NPV of purchasing this insurance for your firm? What is the source of this gain?
a. What is the actuarially fair premium for this insurance?
The actuarially fair premium is?. (Round to the nearest dollar.)
b. What is the NPV of purchasing this insurance for your firm?
The NPV is ?. (Round to the nearest dollar.)
c. What is the source of this gain? (Select the best choice below.)
A. There is no actual gain since the insurance will only make the firm whole again.
B. The gain arises because the firm pays for the insurance when its tax rate is low, but receives the insurance payment when its tax rate is high.
C. The gain arises because the firm is overinsured and, had the loss occurred, the firm would be getting more than the value of the loss.
D. The gain arises because the firm pays for the insurance when its tax rate is high, but receives the insurance payment when its tax rate is low.

Added by Yolanda R.

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