Genentechs main facility is in South San Francisco. Suppose that Genentech would experience a

direct loss of $450 million in the event of a major earthquake that disrupted its operations. The

chance of such an earthquake is 2% per year, with a beta of -0.5.

a) If the risk-free interest rate is 5% and the expected return of the market is 10%, what is the

actuarially fair insurance premium required to cover Genentechs loss?

b) Suppose the insurance company raises the premium by an additional 15% over the amount

calculated in part (a) to cover its administrative and overhead costs. What amount of

financial distress or issuance costs would Genentech have to suffer if it were not insured to

justify purchasing the insurance?