Question: Consider the following loss distribution. Possible damage ($) Probability 0 0.50 400 0.25 1,000 0.14 5,000 0.08 12,000 0.03 Suppose that you are an individual

Consider the following loss distribution.

Possible damage ($)

Probability

0

0.50

400

0.25

1,000

0.14

5,000

0.08

12,000

0.03

Suppose that you are an individual facing this risk.

What is your expected loss?

What is the likelihood you will suffer no loss?

What is the likelihood you will suffer a $12,000 loss?

Now suppose you have 2 other friends facing the identical risk. Suppose, too, that the 3 of you decide to pool your losses.

What is your expected loss?

What is the likelihood you will suffer no loss?

What is the likelihood you will suffer a $12,000 loss?

Why might you want to form the pool even though the likelihood that you will suffer a loss increases?

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