UNIVERSITY OF ILLINOIS AT URBANA CHAMPAIGN College of Business D E PAR T M E N T O F F I NAN C E Finance 230 Fall 2007 Assignment 4 Due September 21 2007 1 The willingness to pay a premium for car insurance that is higher than your expected losses represents A Risk neutrality D Pure risk B E Risk aversion None of the above C Risk seeking behavior Explanation An individual who is risk averse will go out of his her way to avoid a risk so he she would pay the premium for the car insurance In this problem someone who is risk neutral would take this risk and the risk seeker would take this risk See pages 5 7 in Pritchett for further clarification 2 The property damage coverage in the State Farm Car Policy protects you against which of the following exposures A Personal loss exposures B D Moral hazard E Property loss exposures C None of the above Liability loss exposures Explanation Under Coverage A on your Declarations page you will find that property damage liability applies This means that you are not liable for the first 100 000 in property damage that you incur from an accident See pages 10 14 in Pritchett for further clarification 3 Which ideal requisite for insurability is most seriously violated by a policy insuring Bruce Springsteen s voice A Many similar exposure units B D Small possibility of a catastrophe Fortuitous losses E C Definite losses Economic feasibility Explanation Bruce Springsteen has a unique and distinct voice that he uses for singing This means that there are few if any voices like his Due to the lack of exposure units like Bruce Springsteen s voice we know that answer A is most seriously violated See pages 59 64 in Pritchett for further clarification 4 Calculate the expected loss for bodily injury liability insurance if the loss frequency is 3 in 100 and the loss severity is 7 500 A 3 D 2250 B E 30 None of the above C 75 Explanation The equation that we use is the following loss frequency loss severity expected loss Our calculation for this problem would be 03 7 500 225 Since 225 is not a possible answer we come up with E as our answer See pages 35 36 in Pritchett for further clarification 5 The State Farm Car Policy liability coverage can be best classified as which of the following A B C D E Personal property liability private involuntary Commercial life health private voluntary Personal property liability government voluntary Personal property liability private voluntary Personal life health private involuntary Explanation First we know that the policy is personal as it covers a person you rather than a business Next we know that the policy s liability coverage deals with property liability because life health is not applicable to coverage A in the policy Next State Farm is a private company not a government agency so this is a private policy Lastly your policy s liability coverage is involuntary because the state of Illinois requires automobile policies to have a minimum level of liability coverage See pages 65 67 in Pritchett for further clarification 6 The State Farm Car Policy liability coverage excludes bodily injury relatives page 8 item 2 c to avoid violating which of the following ideal requisites for insurability A B C D E Many similar exposure units Fortuitous losses Definite losses Small possibility of a catastrophe Economic feasibility Explanation On page 763 in the Pritchett text fortuitous losses are defined as losses that occur as a matter of chance and are not controlled or influenced by the insured Therefore State Farm excludes bodily injury to a relative to deter insured s from getting into accidents with relatives on purpose An accident between an insured and a relative could occur on purpose rather than as a matter of chance See pages 59 64 in Pritchett for further clarification 7 The State Farm Car policy states that a Temporary Substitute Car means a car not owned by registerted to or leased to you or your spouse if it replaces your car for a short time On September 14 2007 you borrow another car that has no other insurance while your Sebring is for repairs The repairs require ordering parts from abroad that take several weeks to arrive On October 13 2007 you are in an accident with the borrowed vehicle If you file a claim for coverage which would apply A B C D E State Farm could deny the claim by arguing that 30 days is not a short time State Farm would pay the claim since insurance policies are contracts based on utmost good faith State Farm could deny the claim since you did not provide any consideration for this coverage State Farm would have to pay the claim since this is a contract of adhesion None of the above Explanation On pages 84 85 in the Pritchett text the contracts of adhesion section states that insurance policies are contracts of adhesion and when the terms of a policy are ambiguous the courts favor the insured because it is assumed that the insurer that writes the contract should know what it wants to say and how to state it clearly Therefore State Farm would pay your claim since it is not clear whether 29 days is a short time or not See pages 84 85 in Pritchett for further clarification 8 You advertise for a graduate student to take notes for you in Finance 260 by posting a note on the bulletin board in Sherman Hall and offer to pay 100 for a full semester s notes Two days after the final exam a 22 year old law student provides you with a full semester of excellent notes which might have helped you in the class and asks for his 100 You decline to pay him and he sues you Which if any of the requirements for a contract would be missing A B C D E Offer and acceptance Consideration Competent parties Legal purpose None are missing and you would be required to pay him the 100 Explanation On page 80 in the Pritchett text there is a section on offer and acceptance which says an agreement is reached when one party makes an offer and the other party accepts it In the problem you are inviting someone to offer to do this for you You never accepted the law student s offer which came too late for you to be interested Therefore this requirement is missing See pages 80 81 in Pritchett for further clarification 9 You sell your car to a woman who responds to an ad you placed in the newspaper but you mistakenly pay the renewal premium on your insurance policy on the car During the policy term you find out that the woman you sold the car to was in an accident that caused extensive damage to the car Which of the following is true A