Question 1
The risk of fires in whiskey distilleries is a real one, with events such as the serious fire on Heaven Hill distillery in 1996 when ’90,000 barrels of whiskey burned out of control’. When these firms start such a system it is attempting to risk spread; when a firm will spread the risk over other firms and therefore reduce the amount of risk that firm bears.
Using the number of barrels in the Heaven Hill distillery, it is assumed that each distillery can store 90000 barrels and is always storing at full capacity. It is then necessary to assume that each whiskey distillery has two outcomes in a year; no fire or a fire. Adding to this, it is assumed that there is a 5% chance of a fire in a year, and that if there is a fire that all the whiskey will be lost. Now it is possible to begin to calculate the expected number of barrels left in storage after a year.…show more content… of barrels left in storage = E(x)No System = E(x)No Fire + E(x)Fire
= (PNo Fire x BNo Fire) + (PFire x BFire)
= (0.95 x 90000) + (0.05 x 0) = 85,500 barrels
Taking this same model we can start the system by adding a second distillery, Distillery 2, however we are still only looking at the affect of the system on Distillery 1. Distilleries exchange 10% of their stock (9,000 barrels) with each other, no compensation is offered to each other if stock is lost in a fire. The assumptions from the previous model are continued through with one additional assumption; a fire at Distillery 1 is independent from a fire at Distillery 2, therefore the probabilities of a fire at each distillery remain the same no matter what happens at the other.2
