Problem
i. Jensen Manufacturing, which has six factories located in the Northern United States, plans to open a seventh factory in Puerto Rico. Jensen's risk manager is basing loss probability estimates for the new plant exclusively on historical loss data from its existing six factories. The risk manager believes that the combined loss experience from the six plants provides sufficient data to ensure accurate loss predictions and that the law of large numbers applies because the new plant will use the same manufacturing processes and employ a similar number of workers as the existing plants. Explain whether this is the correct approach to assess the new plant's loss probability.
ii. Explain what it means when an organization has a one-day, 5 percent value at risk (VaR) of $500,000 and when another organization has earnings at risk (EaR) of $1,000,000 with 95 percent confidence?