Use the Following Information to Answer the Question(s) Below

question 45

Multiple Choice

Use the following information to answer the question(s) below.

Rearden Metal imports ore from South America. Assume that it is 2016 and Rearden Metal is worried that the South American mines may enter into a long-term contract with the Chinese to sell all of their ore output to China, hence cutting off Rearden Metal's supply. In the event of such a contract with the Chinese, Rearden Metal will face much higher costs for its raw materials causing its operating profits to decline substantially and its marginal tax rate to fall from its current level of 35% down to 10%. An insurance firm has agreed to write a trade insurance policy that will pay Rearden Metal $2,500,000 in the event of the South American supply of ore being cut off. The chance of the South American supply being cut off is estimated to be 20%, with a beta of -2.0. The risk-free rate of interest is 4% and the return on the market is estimated to be 12%.

-The actuarially fair premium for this insurance policy is closest to:

• A)$417,000.
• B)$446,000.
• C)$500,000.
• D)$568,000.

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Definitions:

Production Costs

Expenses incurred in the manufacturing or creation of goods, including labor, materials, and overhead.

Price-Taker Market

A market situation where individual buyers and sellers have no influence over the price of a product due to the product's homogeneity and the presence of many participants.

Profit-Maximizing Firm

A company that operates in a way that its primary goal is to achieve the highest possible profit.

Market Price

The current price at which a good or service can be bought or sold in a marketplace.