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Insurance and Hedging Strategies Analysis

The document presents a problem set focused on insurance and risk management for businesses, exploring the costs and benefits of insuring against potential losses. It includes specific scenarios involving a firm's potential loss, the impact of new policies on loss probability, and the financial implications of different insurance strategies. Additionally, it addresses revenue volatility for a gold-mining firm and examines the effects of hedging through futures contracts and options on total revenue.

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12 views1 page

Insurance and Hedging Strategies Analysis

The document presents a problem set focused on insurance and risk management for businesses, exploring the costs and benefits of insuring against potential losses. It includes specific scenarios involving a firm's potential loss, the impact of new policies on loss probability, and the financial implications of different insurance strategies. Additionally, it addresses revenue volatility for a gold-mining firm and examines the effects of hedging through futures contracts and options on total revenue.

Uploaded by

reminationtv
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Problem Set

1. Large businesses spend millions of dollars annually on insurance. Why? Should they insure
against all risks or does insurance make more sense for some risks than others?.

2. Your firm faces a 9% chance of a potential loss of $10 million next year. If your firm implements
new policies, it can reduce the chance of this loss to 4%, but these new policies have an upfront
cost of $100,000. Suppose the beta of the loss is 0, and the risk-free interest rate is 5%.
(a) If the firm is uninsured, what is the NPV of implementing the new policies?
(b) If the firm is fully insured, what is the NPV of implementing the new policies?
(c) Given your answer to part (b), what is the actuarially fair cost of full insurance?
(d) What is the minimum-size deductible that would leave your firm with an incentive to
implement the new policies?
(e) What is the actuarially fair price of an insurance policy with the deductible in part (d)?

3. A gold-mining firm is concerned about short-term volatility in its revenues. Gold currently
sells for $650 an ounce, but the price is extremely volatile and could fall as low as $630 or rise
as high as $680 in the next month. The company will bring 1,000 ounces to the market next
month. Assume the one month interest rate is zero.
(a) What will be the total revenue if the firm remains unhedged for gold prices of $600, $630,
and $680 an ounce?
(b) The future price of gold for delivery one month ahead is $660. What will be the firm’s
total revenues at each gold price if the firm enters into a one-month futures contract to
deliver 1,000 ounces of gold?
(c) What will total revenues be if the firm buys a one-month put option to sell gold for $650
an ounce? The put option costs $45 per ounce.

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