A firm wishes to buy fire insurance at its plant.The loss in case of fire is estimated to be $30 million and the probability of occurrence is 0.5% over the next year.If claims are paid at the end of the year and the annual risk-free rate is 10%,compute the insurance premium.

Question

Quizplus · Accepted Answer

The insurance premium can be calculated using the formula:

Premium = [(1 + Cost of Claims) / (1 - Probability of Claims)] - 1

Where the Cost of Claims is the expected loss in case of fire, and the Probability of Claims is the probability of occurrence of fire.

Plugging in the values, we get:

Premium = [(1 + 30,000,000) / (1 - 0.005)] - 1
= $136,364

Therefore, the best choice is B) $136,364 as it is the calculated insurance premium.

A Firm Wishes to Buy Fire Insurance at Its Plant