CAS Exam 9 Spring 2017, Question 20
Study guide: Exam 9
A put option pricing function was used to construct the VaR Exceedence Probability Curves below. Use the curves to answer the following questions.
| Line | Premium | Losses | Net Income |
|---|---|---|---|
| 1 | 40 | 25 | 8 |
| 2 | 65 | 35 | 11 |
| 3 | 85 | 50 | 15 |
| Total | 190 | 110 | 34 |
- The firm's cost of capital is 9%.
- The firm chooses an exceedence probability of 5% to allocate capital.
Part a (0.5 points)
Discuss how value maximization is affected by capital allocation.
Part b (1.5 points)
For each line, using the exceedence probability curves, demonstrate how this insurer can increase its shareholder value.
Part c (0.5 points)
Describe an issue with allocating capital based on exceedence probabilities.
Answer this question and see the worked solution