Value at Risk P3 Question from Kaplan Practice kit

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June 11, 2019 at 8:05 am #520169
allanjnr7
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18. X is a company involved in oil exploration and extraction. Following a risk review, X has
identified that earthquakes occur in its exploration areas once every five years, on average.
The average cost of work to resume oil production, following an earthquake, is estimated to
be US$ 30million.
Calculate the value of the risk of earthquakes, in US$, to the nearest million.
June 11, 2019 at 8:55 am #520175
Ken Garrett
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Which part of the model answer is giving you problems? The question would be better worded if it said:

“Calculate the annual value of the risk of earthquakes…”
June 11, 2019 at 9:14 am #520177
allanjnr7
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All I have is the questions without any model answers.So that’s why i wanted to find out how would the answer be calculated in this case.In the case of calculating the “annual value at risk of earthquakes”what steps should i take to providing the right answer?
June 11, 2019 at 9:26 am #520182
Ken Garrett
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If an earthquake occurs on average every 5 years, the probability of it happening in any one year must be 1/5 or 20%.

Therefore the expected annual cost of an earthquake is 30m x 20% = $6M
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