1.Sarah has the option to buy home insuranceon a home that is worth $100 000. Po
ID: 3127154 • Letter: 1
Question
1.Sarah has the option to buy home insuranceon a home that is worth $100 000. Policy A has a premium of $10 per year and will pay her 90% of her home’s value in the event that it is destroyed in a fire. Policy B has a premium of $20 per year and will pay her 100% ofher home’s value in the event that it is
destroyed in a fire. In a given year, there is a 1% chance of a fire. (We assume that Sarah assigns utilities using dollars.)
(a) Determine the expected value of buying policy A.
(b) Determine the expected value of buying policy B.
(c) Which policy should Sarah buy if she can buy only one?
Explanation / Answer
Insurance Buy B Premium 10 20 Fire 0.01 0.01 Gain 90000 100000 Gain *prob 900 1000 Prem 10 20 Net gain 890 980 Exp value 890 980 She can buy B as expected value of policy Is more for B than .A
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