1) Your firm faces a potential $10 million loss that it would like to insure. Because of tax benefits and the avoidance of financial distress and issuance costs, each $1 received in the event of a loss is worth $2 to the firm. Two policies are available: One pays $5 million and the other pays $10 million if a loss occurs. The insurance company charges 30% more than the actuarially fair premium to cover administrative expenses. To account for adverse selection, the insurance company estimates a 3% probability of loss for the $5 million policy and a 4% probability of loss for $10 million policy. Suppose the beta of the risk is -0.6, the risk-free rate is 2%, and the expected market return is 10% and the WACC is 0.084

a. Which policy should the firm choose if its risk of loss is 3%? Whats the NPV of this choice?

b. Which policy should the firm choose if its risk of loss is 4%? Whats the NPV of this choice?

2) According to the Standards of Practice Handbook 14^th Edition, as a CFA member, what are his/her duties to clients?

3) List the factors that might influence a firms choice of capital structure in the real life and explain how each factor affects the optimal leverage ratio in the context of tradeoff theory?