Question

Which of the following statements is FALSE?

Select one:

A. In a perfect market without other frictions, insurance companies should compete until they are just earning a fair return and the NPV from selling insurance is zero. The NPV is zero if the price of insurance equals the present value of the expected payment; in that case, we say the price is actuarially fair.

B. Because insurance reduces the risk of financial distress, it can relax this tradeoff and allow the firm to increase its use of debt financing.

C. By lowering the volatility of the stock, insurance discourage concentrated ownership by an outside director or investor who will monitor the firm and its management.

D. When a firm is subject to graduated income tax rates, insurance can produce a tax savings if the firm is in a higher tax bracket when it pays the premium than the tax bracket it is in when it receives the insurance payment in the event of a loss.

Answer 1

Ans C. By lowering the volatility of the stock, insurance discourage concentrated ownership by an outside director or investor who will monitor the firm and its management.

Correct statement is: By lowering the volatility of the stock, insurance encourage concentrated ownership by an outside director or investor who will monitor the firm and its management.