Why Is a Large Number of Exposure Units Generally Required

question 17

Multiple Choice

Why is a large number of exposure units generally required before a pure risk is insurable?

• A)It prevents the insurer from losing money.
• B)It eliminates intentional losses.
• C)It minimizes moral hazard.
• D)It enables the insurer to predict losses more accurately.

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Definitions:

Trade-Off Theory

The addition of financial distress and agency costs to either the MM tax model or the Miller model. When trade-off is added to either model, the optimal capital structure can be visualized as a trade-off between the benefit of debt (the interest tax shield) and the costs of debt (financial distress and agency costs).

Debt Financing

A method of funding in which a company raises capital by borrowing money, agreeing to repay the principal amount along with interest on a specified schedule.

MM Model

The Modigliani-Miller theorem, proposing that in perfect markets, the value of a firm is unaffected by its capital structure.

Miller Model

A model formulated by Merton Miller, part of the Modigliani-Miller theorem, which discusses the irrelevance of capital structure for a company's market value under certain assumptions.