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UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGNCollege of BusinessD E P A R T M E N T O F F I N A N C E Finance 230 Assignment 4Fall, 2007 Due: September 21, 20071. The willingness to pay a premium for car insurance that is higher than your expected losses represents:A. Risk neutrality B. Risk aversion C. Risk seeking behaviorD. Pure risk E. None of the aboveExplanation: 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 wouldtake 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. Property loss exposures C. Liability loss exposuresD. Moral hazard E. None of the aboveExplanation: 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. Fortuitous losses C. Definite lossesD. Small possibility of a catastrophe E. Economic feasibilityExplanation: 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 B. $30 C. $75D. $2250 E. None of the aboveExplanation: 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. Personal, property-liability, private, involuntaryB. Commercial, life-health, private, voluntaryC. Personal, property-liability, government, voluntaryD. Personal, property-liability, private, voluntaryE. Personal, life-health, private, involuntaryExplanation: 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. Many similar exposure unitsB. Fortuitous lossesC. Definite lossesD. Small possibility of a catastropheE. Economic feasibilityExplanation: 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 Farmexcludes 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, youare in an accident with the borrowed vehicle. If you file a claim for coverage, which would apply?A. State Farm could deny the claim by arguing that 30 days is not a short timeB. State Farm would pay the claim since insurance policies are contracts based on utmost good faithC. State Farm could deny the claim since you did not provide any consideration for this coverageD. State Farm would have to pay the claim since this is a contract of adhesionE. None of the aboveExplanation: 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. Offer and acceptanceB. ConsiderationC. Competent partiesD. Legal purposeE. None are missing and you would be required to pay him the $100Explanation: 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


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UIUC FIN 230 - Assignment 4 Key - With Explanations

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