Reference no: EM132921460

A museum has bought a new painting by a famous artist. The painting is worth $1 million and is now the museum's main attraction. The museum is worried that the painting might get stolen. They estimate the one-year theft probability as 5%. They consider three alternatives:

-Do nothing.

-Hire a security firm. The price for 24/7 security services is $70,000 per year. The museum estimates that the security service will reduce the theft probability to 1%.

-Buy theft insurance. The insurance premium is $90,000 per year. The insurance will reimburse the museum for the loss of the painting in case the painting is stolen.

(a) Compare the three alternatives under the expected value strategy and the minimax regret strategy. Identify the preferred alternative under each of the two strategies.

(b) Based on (a), recommend the alternative the museum should choose. Justify your choice.

(c) The insurance company offers to reduce the insurance premium if the museum hires the security firm. Calculate the new insurance premium assuming the same expense ratio as in alternative 3. above. Comment on the result.

(d) Identify the top three other risks that the museum might face. Based on the severity and frequency of these risks, explain how these risks should be managed.