How should a Microsoft Excel sheet be completed for the following problem:

Cases in Healthcare Finance

, 6th Edition

12/1/2017

CASE 12 QUESTIONS

MID-ATLANTIC SPECIALTY, INC.

Financial Risk

1.

Compare the stand-alone risk/expected return of each of the four investments and the S&P 500

listed in exhibit 12.1.

a.

Please refer to excel sheet

2.

MSI is considering two investment strategies:

refer to excel sheet

- 50 percent in Healthcare Fund and 50 percent in Inverse ETF

- 50 percent in Healthcare Fund and 50 percent in Biotech Fund

Compare the risk of the two portfolios. Why does the risk differ?

When the returns for healthcare fund are low the returns of inverse ETF are high and vice

versa, making them negatively corelated hence the negative correlation coefficient. The returns of

healthcare fund and biotech fund are positively correlated hence the positive correlation coefficient.

3.

a.

Use the historical returns in exhibit 12.2 to create a graph with market characteristic lines for a 1-

year T-Bill, Healthcare Fund, Inverse ETF, and Biotech Fund. Compare the market risk of each of

the four investments.

refer to excel sheet

b.

What would happen to the overall risk of a well-diversified portfolio with an investment in a

1-Year T-Bill? Healthcare Fund? Inverse ETF? Biotech Fund?

i.

Since a beta of 1.0 indicates that a project's return has same degree of

changeability as the market. The only portfolio above 1.0 was biotech, so the other

three would reduce the risks of a portfolio, but biotech would increase the risk.

c.

What does the distance between the market characteristics line and the expected return of

an investment indicate?

i.

Diversifiable risk is shown on the regression line by looking at the distance

between the points on from the line. Based on this and my graph, year one is spot

on the line where as inverse ETF has the furthest space between its points and the

lines. This indicates that year one has no diversifiable risk, whereas inverse ETF

shows the most diversifiable risk. The points for healthcare and biotech are close to

their lines showing minimal diversifiable risk.

4.

a.

Construct a Security Market Line graph and plot the expected return of each investment on the

graph.

refer to excel sheet

b.

If you were an individual investor with a well-diversified portfolio, which investment(s) in exhibit 12.1

would you buy? Why?

As an investor inverse ETF would be the best choice due to the beta value being

negative and having the highest required return. The next best choice would be healthcare fund

followed by 1-yer t-bill. Biotech fund would be the last choice because it has the highest beta and a

negative required return.

c.

What does the distance between the Security Market Line and the expected return of an investment

indicate?

The distance indicated the difference between the expected rate and the

required rate of return on a stock, also known as excess return

.

Copyright 2018 Foundation of the American College of Healthcare Executives.

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Case Questions Cases in Healthcare Finance

5.

a.

Is the return on the one-year T-bill risk free?

The payments should be made unless an unexpected event occurs. The T-bill offers same

return (7%) no matter what the exonymic state is and therefore is reasonably risk free. It is

considered risk free only in the sense of nominal. Even though the investor is guaranteed a 7%

nominal return, it will ultimately depend on inflation over the next year, making the real return

uncertain. For instance, if the interest rate increase then the bill's price will decline and then you

should sell the bill to raise cash to prevent getting less than 7% in return.

b.

Suppose MSI wants to construct a portfolio of stocks that has an expected return equal to the risk-

free rate. Is such a portfolio possible? Is such a portfolio likely?

If the portfolio has a beta equal to zero, then this would be possible. However, in practice

it is unlikely to find a stock that have non-positive betas and therefore it would be impossible to have

a stock portfolio with a zero beta.

c.

Suppose that you choose to hold a single stock investment in isolation. Would you be compensated

for all of the risk that you assume? Explain.

It is not likely that you will be compensated for your risks sense you chose to take

them. If there were to be a stock that was priced low enough to provide a return that would

essentially compensate your risk, then the returns would look like a good option to diversified

investors. They would then bid the price up and lower the expected future return for diversified

investors meaning diversified investors are in key components for determining price.

6.

In your opinion, what are three key learning points from this case?

- returns determine the risk of a portfolio

- one way to decide whether to buy or sell is to compare required rate of return for each

- beta values are important for determining the volatility of the project returns

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