Neighborhood Insurance sells fire insurance policies to local homeowners. The premium is $350, the probability of a fire is 0.1%, and in the event of a fire, the insured damages (the payout on the policy) will be $340,000. a. Make a table of the two possible payouts on each policy with the probability of each.

Payout of No Fire: ANS. 350

Payout of Fire: ANS. (339,650)

b. Suppose you own the entire firm, and the company issues only one policy. What are the expected value, variance and standard deviation of your profit? Expected return: ANS. $10

Variance: unsure

Standard deviation: unsure

c. Now suppose your company issues two policies. The risk of fire is independent across the two policies. Make a table of the three possible payouts along with their associated probabilities. (Round your "Probability" answers to 4 decimal places.)

	outcome no fire	outcome one fire	outcome two fires
payout
probability	%	%	%

unsure^

d. What are the expected value, variance and standard deviation of your profit?

expected return	variance	standard deviation

unsure^

e. Compare your answers to (b) and (d). Did risk pooling increase or decrease the variance of your profit? Risk pooling:____________ The total variance of profit.

f. Continue to assume the company has issued two policies, but now assume you take on a partner, so that you each own one-half of the firm. Make a table of your share of the possible payouts the company may have to make on the two policies, along with their associated probabilities. (Round your "Probability" answers to 4 decimal places.)

	outcome no fire	outcome one fire	outcome two fires
payout
probability	%	%	%

g. What are the expected value and variance of your profit?

Expected Return	Variance	Standard deviation
$