An operator of an oil well has a 0.5% chance of experiencing a catastrophic failure.This failure will cost the operator $500 million.If the risk-free rate is 2%,the expected return on the market is 8%,and the beta of the risk is 0,what is the actuarially fair insurance premium?
A)$2,450,980
B)$2,500,000
C)$2,550,000
D)$2,314,815
E)$2,715,225

Question

Quizplus · Accepted Answer

The actuarially fair insurance premium is the expected loss multiplied by the risk-free rate. The expected loss is the probability of a catastrophic failure multiplied by the cost of the failure. The risk-free rate is the rate of return on a risk-free investment. In this case, the probability of a catastrophic failure is 0.5%, the cost of the failure is $500 million, and the risk-free rate is 2%. Therefore, the actuarially fair insurance premium is 0.5% * $500 million * 2% = $2,500,000.

An Operator of an Oil Well Has a 0