BU353 Lecture Notes - Lecture 11: Blood Test
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Price a 2(3) year term for a 51 year old, benefit = 100,000, r = 4% = present value first year payment * probability (pay in first year) + present value of second year payment * probability (pay in second year) + present value of third year payment * probability (pay in third year) = 100,000/1. 04 * pr (51 year old dies between 51 & 52) + 100,000/1. 04^2 * pr (51 year old dies between 52 & 53) + 100,000/1. 04^3 * pr (51 year old dies between 53 & 54) In every term denominator is number alive when contract was purchased. Note: in your assignment, you need to have the correct denominators. Options: buy two 1-year contracts, buy 2-year contract with one payment, buy 2-year contract with two payments. Expected present value of all payments should all be the same. If there is different value, which means that you have mistakes somewhere in your pricing.
