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 40% to 10%.
An insurance firm has agreed to write a trade insurance policy that will pay $500,000 in the event of an import moratorium. The chance of a moratorium is estimated to be 10%, with a beta of −1.5. Suppose the risk-free interest rate is 5% and the expected return of the market is 10%.
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?

  • CreatedAugust 06, 2014
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