Your firm imports manufactured goods from China. You are worried that U.S.China trade negotiations could break down
Question:
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?
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...
Step by Step Answer:
a From the SML the required return for a beta of 15 is r L 5 1510 5 25 ...View the full answer
