Question

CASE 12 MID-ATLANTIC SPECIALTY, INC: Financial Risk							12/1/17
Copyright 2018 Foundation of the American College of Healthcare Executives. Not for sale.
	Model without Questions, Student Version
Case 12 deals with basic financial risk concepts of a medical group practice facing alternative
investment opportunities.
The student version of the model is a format guide only because the objective is for students to attempt
basic calculations themselves. The key to student success in this case lies in correct calculations and
interpretation of the data.
Estimated one-year return distributions:
State of the		1-Year	Healthcare	Inverse	Biotech	S&P
Economy	Probability	T-Bill	Fund	ETF	Fund	500
Poor	0.1	7%	-8%	18%	-19%	-15%
Below average	0.2	7%	2%	23%	0%	0%
Average	0.4	7%	14%	7%	13%	15%
Above average	0.2	7%	25%	-3%	31%	30%
Excellent	0.1	7%	33%	2%	50%	45%
Historical return distributions:

		1-Year	Healthcare	Inverse	Biotech	S&P
		T-Bill	Fund	ETF	Fund	500
Year 1		7%	-8%	18%	-19%	-15%
Year 2		7%	2%	23%	0%	0%
Year 3		7%	14%	7%	13%	15%
Year 4		7%	25%	-3%	31%	30%
Year 5		7%	33%	2%	50%	45%
Stand-alone return and risk:
		1-Year	Healthcare	Inverse	Biotech	S&P
		T-Bill	Fund	ETF	Fund	500
Expected return [E(R)]
Variance (Var)
Standard deviation (SD)
Coefficient of variation (CV)

Portfolio return and risk:
		E(R) of		E(R) of
		Portfolio		Portfolio
State of the		Healthcare Fund /		Healthcare Fund /
Economy		Inverse ETF		Biotech Fund
Poor
Below average
Average
Above average
Excellent
		Portfolio		Portfolio
		Healthcare Fund /		Healthcare Fund /
		Inverse ETF		Biotech Fund
Expected return [E(R)]
Variance (Var)
Standard deviation (SD)
Coefficient of variation (CV)
Correlation coefficient

Market characteristic lines:
	S&P	1-Year	Healthcare	Inverse	Biotech
	500	T-Bill	Fund	ETF	Fund
Intercept
Market beta
Data point
Data point
Data point
Data point
Data point
Market Characteristic Lines
Security market line:
		1-Year	Healthcare	Inverse	Biotech
		T-Bill	Fund	ETF	Fund
Risk-free rate
Required market return
Market beta
Investment required return
Investment expected return
Difference
Security Market Line

Answer 1

Historical returns for the various investment options are given below,

1-Year	Healthcare	Inverse	Biotech	S&P
		T-Bill	Fund	ETF	Fund	500
Year 1		7%	-8%	18%	-19%	-15%
Year 2		7%	2%	23%	0%	0%
Year 3		7%	14%	7%	13%	15%
Year 4		7%	25%	-3%	31%	30%
Year 5		7%	33%	2%	50%	45%

For the year 6 the expected return from the investment as per different economic scenario is given below

Estimated one-year return distributions:
State of the		1-Year	Healthcare	Inverse	Biotech	S&P
Economy	Probability	T-Bill	Fund	ETF	Fund	500
Poor	0.1	7%	-8%	18%	-19%	-15%
Below average	0.2	7%	2%	23%	0%	0%
Average	0.4	7%	14%	7%	13%	15%
Above average	0.2	7%	25%	-3%	31%	30%
Excellent	0.1	7%	33%	2%	50%	45%

Expected return for each investment in year 6 will be,

1 Year T bill = .1 * 7 + .2 * 7 + .4 * 7 + .2 * 7 + .1 * 7 = .7 + 1.4 + 2.8 + 1.4 + .7 = 7 %

Health Care Fund = .1 * -8 + .2 * 2 + .4 * 14 + .2 * 25 + .1 * 33 = -.8 + .4 + 5.6 + 5 + 3.3 = 13.5 %

Inverse ETF = .1 * 18 + .2 * 23 + .4 * 7 + .2 * -3 + .1 * 2 = 1.8 + 4.6 + 2.8 -.6 + .2 = 8.8 %

Biotech Fund = .1 * - 19 + .2 * 0 + .4 * 13 + .2 * 31 + .1 * 50 = -1.9 + 0 + 5.2 + 6.2 + 5 = 14.5 %

S & P 500 = .1 * - 15 + .2 * 0 + .4 * 15 + .2 * 30 + .1 * 45 = -1.5 + 0 + 6 + 6 + 4,5 = 15 %

Variance of each of the investment can be calculatted as,

1 Year T bill = VAR(7,7, 7,7,7,7) = 0

Health Care Fund = VAR(8, 2,14 ,25,33,13.5) = 221.3

Inverse ETF = VAR(18 ,23, 7, -3 ,2 ,8.8) = 94.7

Biotech Fund = VAR(19, 0 ,13 ,31,50,14.5) = 573.2

S & P 500 = VAR(-15 ,0 ,15 ,30 ,45 ,15) = 450

Standard deviation for each of the investment,

1 Year T bill = STDEV(7,7, 7,7,7,7) = 0

Health Care Fund = STDEV(8, 2,14 ,25,33,13.5) = 14.8

Inverse ETF = STDEV(18 ,23, 7, -3 ,2 ,8.8) = 9.7

Biotech Fund = STDEV(19, 0 ,13 ,31,50,14.5) = 23.9

S & P 500 = STDEV(-15 ,0 ,15 ,30 ,45 ,15) = 21.2

Average return for each of the investment,

1 Year T bill = AVERAGE(7,7, 7,7,7,7) = 7

Health Care Fund = AVERAGE(8, 2,14 ,25,33,13.5) = 13.2

Inverse ETF =AVERAGE(18 ,23, 7, -3 ,2 ,8.8) = 9.3

Biotech Fund =AVERAGE(19, 0 ,13 ,31,50,14.5) = 14.9

S & P 500 = AVERAGE(-15 ,0 ,15 ,30 ,45 ,15) = 15

Coefficient of variation (CV) for each investment is the deviation per unit of return,

1 Year T bill = 0/7 = 0

Health Care Fund = 14.8/13.2 = 1.12

Inverse ETF = 9.7/9.3 = 1.04

Biotech Fund = 23.9/14.9 = 1,6

S & P 500 = 21.2/15 = 1.4

N.B - As part of HOMEWORKLIB RULES we can answer first four of any multipart question.