Problem set 5 questions from a Finance 4335 student…

A student asked me the following questions about Problem Set 5 (due at the beginning of class on Tuesday, October 3):

Question 1: “I am having trouble with Problem Set 5. What exactly does Part A mean when it asks for premium loading? I cannot seem to recall in my notes what exactly that is and how it applies to this problem.”

My Answer to Question 1: In insurance, the premium loading corresponds to the “markup” from the actuarially fair value. Part A asks for the premium loading in dollar and percentage terms, so you need to figure out what the actuarially fair value is for the policy and compare that to the quoted price.

Question 2: “And for Part B, am I right to assume that the “optimal” level of insurance coverage is being calculated with the $240 insurance premium that is given in the problem?”

My Answer to Question 2: Yes.

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