CFA-Level-2 – Chartered Financial Analyst Level 2

Richard Grass is the healthcare analyst for Furrnon Investments and is reviewing the investment merits of the developing hospice industry. The hospice industry has a short history in the public market, as several companies have recently completed their initial public offering. Hospice services are provided to patients diagnosed with terminal illness as an alternative to aggressive medical management. The use of hospice services at skilled nursing facilities and assisted-living facilities is forecasted to continue its recent growth. Medicare is the primary payer for hospice services, accounting for 85% of the approximately $7 billion in industry's revenues. Hospice providers offer symptom and pain management to patients diagnosed with a terminal illness by their physician. The program was added to the Medicare benefit package in the early 1980s. Growth in the sector has only recently. accelerated due to the emergence of a number of for-profit companies. The caregiver provides a plan for each admitted patient and care is given in any number of healthcare environments, including the patient's home.

Grass's analysis of the hospice industry has uncovered several facts that are outlined below:

• The industry's revenue annual growth rate has increased from 14% in the late 1990s to 25% in2008.

• The average length of stay at facilities for hospice patients is increasing.

• Labor costs account for 75% of total expenses, drugs 15% of total expenses, and medicalsupplies 10%.

• More than 80% of hospice patients are above 65 years old and 30% are above 85 years old.

• Based on the U.S. Census Bureau's statistics, over the next six years (2009-2015), the numberof people in the 65 and older age group will increase annually by 1.4%.

• The Medicare hospice benefit is still underutilized by the terminally ill population, according toMedPac (an independent advisory committee for the U.S. Congress on healthcare issues).

• Only 30% of Medicare beneficiaries enroll in the hospice benefit before they die.

• In recent years, the U.S. government has approved rate increases for the sector compared to flator declining rate trends for other healthcare services.

• The Medicare hospice program has a beneficiary cap which cannot exceed approximately$18,000 annually per person.

• The top six for-profit providers account for about half of the segment's sales.

• The overall hospice provider market is roughly divided into 55% non-profit, 10% U.S.government, and 35% for-profit.

Grass's analysis has narrowed his search to Hope Company. Hope controls about 7% of the total hospice service market or 20% of the for-profit market. The company has the only regulator approved for-profit certificate for the state of Florida, one of the most attractive markets in the United States. In addition to a strong market share in Florida, Hope has a strong presence in urban markets like Dallas and San Francisco. Hope has a more diversified revenue base than other publicly traded for-profit providers.

Grass is concerned about potential risks that would change his view of the investment merits for the hospice industry. Based on the facts presented, identify the greatest risk for the hospice industry, relying on your understanding of Porter analysis.

Ryan Hendricks serves as a security analyst for Investment Management, Inc. (IMI), which employs the Treynor-Black model to evaluate securities and to make portfolio recommendations. IMI uses the capital asset pricing model (CAPM) to determine the degree to which securities may be mispriced relative to IMFs forecasts.

Hendricks evaluates the common shares of Computer Software Associates (CSA), a small company specializing in a unique computer software market niche. Hendricks obtains the following market model results for CSA, using monthly returns for the past 60 months:

Hendricks uses the adjusted beta method to derive his forecasts for companies' future betas. In deriving his forecast for any company beta, Hendricks uses the following first-order autoregressive formula:

forecast beta = 0.33 + 0.67 x (historical beta) (2)

Hendricks derives required returns for individual securities using the CAPM after making appropriate adjustments using his adjusted beta formula in equation (2).

IMI provides Hendricks with the following capital market forecasts to use as inputs for the CAPM.

IMI asks Hendricks to make decisions to take long and short positions in individual securities for

IMl's actively managed portfolio, IMI-Active. Specifically, Hendricks is asked to examine CSA and Millennium Drilling (MD), an oil and gas drilling company specializing in deep sea drilling. After a thorough examination of the prospects for each company, Hendricks derives the following alpha forecasts for CSA and MD.

Hendricks forecasts that the unsystematic variance (the variance of the market model regression error) for MD will be more than double that of CSA.

After determining the appropriate allocations across securities within the IMI-Active portfolio, Hendricks derives the portfolio predictions shown in Exhibit 3.

IMI forecasts that the total standard deviation for the S&P500 returns will equal 20%. After examining the historical forecasting abilities of Hendricks, IMI determines that Hendricks has demonstrated perfect forecasting ability in regards to CSA stock, but imperfect forecasting abilities in regards to MD stock. IMI finds that the correlation between the realized alphas for MD and the forecast MD alphas provided by Hendricks equals 0.50.

Referring to the Treynor-Black model, Hendricks makes the following statements:

Statement 1: All else equal, the Treynor-Black model increases the weight to the active portfolio as its unsystematic risk increases.

Statement 2: The Treynor-Black model is based on the premise that only a limited number of stocks should be included in the actively managed portfolio.

Using the Treynor-Black model along with the alpha and unsystematic variance information for CSA and MD, should CSA or MD receive a larger weight within the IMI-Active portfolio?

Voyager Inc., a primarily internet-based media company, is buying The Daily, a media company with exposure to newspapers, television, and the internet.

Voyager's acquisition of The Daily is The company's second major acquisition in its history. The previous acquisition was at the height of the merger boom in the year 2000. Voyager purchased the Dragon Company at a premium to net asset value, thereby doubling the company's size. Voyager used the pooling method to account for the acquisition of Dragon; however, because of FASB changes to the Business Combination Standard, Voyager will use the acquisition method to account for the Daily acquisition.

Voyager has made an all-cash offer of $45 per share to acquire The Daily. Wall Street is skeptical about the merger. While Voyager has been growing its revenues by 40% per year, The Daily's revenue growth has been less than 2% per year. Michael Renner. the CFO of Voyager, defends the acquisition by stating that The Daily has accumulated a large amount of tax losses and that the combined company can benefit by immediately increasing net income after the merger. In addition, Renner states that the New Voyager will eliminate the inefficiencies of the internet operations and thereby boost future earnings. Renner believes that the merged companies will have a value of $17.5 billion.

In the past, The Daily's management has publicly stated its opposition to merging with any company, a position management still maintains. As a result of this situation, Voyager submitted their merger proposal directly to The Daily's board of directors, while the firm's CEO was on vacation. Upon returning from vacation, The Daily's CEO issued a public statement claiming that the proposed merger was unacceptable under any circumstances.

Voyager used the pooling of inierests method when accounting for the 2000 acquisition of Dragon, rather than the acquisition method it would use today. Which of the following is least likely a feature of the pooling of interests method?