Consider the situation of an insurance company which offers personal injury policies to professional hockey players. The typical payoffs to one of these policies are forecast to be the following:
|
State
|
Prob.
|
Payoff
|
|
Athlete is seriously injured
|
0.01
|
-5,000,000
|
|
Athlete is not injured seriously
|
0.99
|
60,000
|
What is the expected profit per policy? Assuming the returns are uncorrelated policy to policy, how many policies must be sold in order for the standard deviation of the firm's overall portfolio of injury policies to be below $10,000?