Eaton Corporation imports materials from a South African supplier. Assume that it is 2020 and Eaton Corporation
Question:
Eaton Corporation imports materials from a South African supplier. Assume that it is 2020 and Eaton Corporation is worried that the South African supplier may enter into a long-term contract with Chinese customers to sell all of their output to the Chinese customers, hence cutting off Eaton Corporation's supply. In the event of such a contract with the Chinese customers, Eaton Corporation will face much higher costs for its raw materials causing its operating profits to decline substantially and its marginal tax rate to fall from its current level of 25% down to 10%. An insurance firm has agreed to write a trade insurance policy that will pay Eaton Corporation $3,400,000 in the event of the South African supply of materials being cut off. The chance of the South African supply being cut off is estimated to be 30%, with a beta of -1.50.
The risk-free rate of interest is 3% and the return on the market is estimated to be 10%. What is the actuarially fair insurance premium?
