Andrew W. Lo is the Charles E. and Susan T. Harris Professor at the MIT Sloan School of Management, director of the MIT Laboratory for Financial Engineering, and an external faculty member at the Santa Fe Institute. His books include Adaptive Markets and Hedge Funds (both Princeton). Shomesh E. Chaudhuri is a cofounder of QLS Advisors. He has published articles in such journals as the Journal of Financial Economics, the Journal of Econometrics, Management Science, JAMA Oncology, and Drug Discovery Today.

"Finalist for the PROSE Award in Reference Works – Social Sciences, Association of American Publishers"

• PrefaceDedication and Acknowledgments, Shomesh E. ChaudhuriDedication and Acknowledgments, Andrew W. Lo1 Why Healthcare Finance?1.1 Financing: The Lifeblood of Biomedical Innovation1.2 Being Harvey Lodish1.3 Convergence1.4 Biomedicine from a Financial PerspectivePROFILE OF A LEADING HEALTHCARE INSTITUTION: NATIONAL INSTITUTES OF HEALTH (NIH)1.5 The Challenges of Drug DevelopmentPROFILE OF A LEADING HEALTHCARE INSTITUTION: NATIONAL CENTER FOR ADVANCING TRANSLATIONAL SCIENCES (NCATS)1.6 What Do Investors Want?1.7 Financial Engineering Can Help Bridge the Valley of Death1.8 RoadmapCONCEPT CHECK ANSWERSREFERENCES2 From the Laboratory to the Patient2.1 Early-Stage Research and Development2.2 Technology Licensing2.3 Biotech Start-Up2.4 The Role of Nonprofit Organizations2.5 Later-Stage Clinical Development2.6 The Growing Importance of Universities and Academic Medicine2.7 Post-Approval Commercialization and Distribution2.8 Patent Expiration, Generics, and Pricing2.9 Commercial Health Insurers2.10 Recent Trends in Industry Consolidation2.11 ConclusionKEY POINTSREFERENCES3 Present Value Relations3.1 Assets as Sequences of Cash Flows3.2 Assets and the Time Value of Money3.3 Using Discount Rates to Determine an Asset’s Net Present Value3.4 Future Value of a Current Cash FlowPROFILE OF A LEADING HEALTHCARE ECONOMIST: DANA GOLDMAN3.5 The Risk Premium3.6 An Infinite Cash Flow: The Perpetuity Formula3.7 A Finite Number of Fixed Cash Flows: The Annuity FormulaPROFILE OF A LEADING HEALTHCARE ECONOMIST: TOMAS J. PHILIPSON3.8 Inflation3.9 Inflation and Biomedicine3.10 NPV versus Value versus PriceKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SETREFERENCES4 Evaluating Business Opportunities4.1 Valuing a Typical Biomedical Program4.1a Probability of Success and Duration4.1b CostsTHE COST OF AN APPROVED DRUG4.1c Revenues4.1d Discounted Cash Flows and rNPV4.2 Valuing a Typical Biopharma Company4.2a Portfolio Constituents4.2b Consolidated Financials4.3 Deciding to Undertake or Shut Down a Project: The NPV Decision Rules4.3a Use Cash Flows, Not Accounting Earnings, When Calculating NPV4.3b Use After-Tax Cash Flows4.3c Use Cash Flows on an Incremental Basis4.4 Accounting Basics for Capital Budgeting4.5 How to Use Accounting Data to Estimate Cash Flows4.6 Other Capital Budgeting Techniques4.6a Profitability Index4.6b Payback Period4.6c Internal Rate of Return4.6d Industry Practices4.7 Discounted Cash Flow Analysis of Artemis Biotherapeutics4.7a Program Overview4.7b Time Line and Probability of Transition Success (PoTS)4.7c Program Revenues4.7d Program Expenses4.7e Discounted Cash Flow Analysis4.8 ConclusionKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SETREFERENCES5 Valuing Bonds5.1 Overview of Fixed-Income Markets5.2 Valuing Discount Bonds and the Term Structure of Interest Rates5.3 Forward Rates5.4 Coupon Bonds5.5 Yield to Maturity5.6 Corporate Bonds5.7 The Yield Spread: Sources of Risk5.8 Bonds and Biopharma CompaniesKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SETREFERENCES6 Valuing Stocks6.1 Legal Characteristics of Stocks6.2 Stock Markets6.3 Valuing Stocks Using the Dividend Discount Model6.4 The Gordon Growth Model6.5 The Multistage Valuation Model6.6 Modeling Dividends via Payout Policy6.7 Growth OpportunitiesKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SETREFERENCES7 Portfolio Management and the Cost of Capital7.1 Measuring the Randomness of Returns7.2 Portfolio Returns and Diversification7.3 The Limits of Diversification7.4 Estimating the Cost of Capital7.5 Deriving the CAPM and Estimating Beta7.6 The Weighted-Average Cost of Capital7.7 The Cost of Capital in the Biopharma IndustryPROFILE OF A LEADING HEALTHCARE ECONOMIST: SCOTT E. HARRINGTONKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SETREFERENCES8 Therapeutic Development and Clinical Trials8.1 Introduction to Pharmaceutical R&D8.1a Drug DevelopmentPROFILE OF A LEADING HEALTHCARE INSTITUTION: FDA8.1b Device Development8.2 Clinical Trials by the NumbersPROFILE OF A LEADING BIOPHARMA PROFESSIONAL: RICHARD SCHELLER8.3 Unique Challenges for Medical Devices8.4 Randomized Clinical Trial Design8.5 Size, Power, and Cost8.6 Bayesian Adaptive Clinical Trials8.7 Bayesian Decision Analysis and Patient PreferencesKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SET: THE STATISTICS OF CLINICAL TRIAL DESIGNREFERENCES9 Decision Trees and Real Options9.1 Overview of Decision Trees and OptionsPROFILE OF A LEADING BIOPHARMA PROFESSIONAL: JUDY C. LEWENT9.2 Decision Tree Analysis9.2a Constructing a Decision Tree9.2b Decision Tree Analysis for Pharmaceutical R&D9.3 Decision Trees and Optionality9.3a Additional Options9.3b Managing Complexity9.4 Real Options and the Binomial Option-Pricing Model9.5 Building a Binomial Tree9.6 Incorporating Scientific Risk9.7 The Binomial Option-Pricing Model9.7a The Two-Period Binomial Option-Pricing Model9.7b The Multiperiod Binomial Option-Pricing ModelKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SET: abc pharmaceuticals case studyREFERENCES10 Monte Carlo Simulation10.1 Why Simulate?10.2 Applications of Monte Carlo SimulationKEY POINTSCONCEPT CHECK ANSWERS11 Healthcare Analytics11.1 Estimating Clinical Trial Success RatesPROFILE OF A LEADING HEALTHCARE INSTITUTION: TUFTS CENTER FOR THE STUDY OF DRUG DEVELOPMENT (TUFTS CSDD)11.2 Predicting Drug Approvals11.3 Machine-Learning Predictions of Probabilities of Success11.4 Modeling Correlation11.4a Correlation via Latent Variables11.4b Estimating Correlations via Subjective Judgment11.5 Simulating Correlated Random Variables11.6 ConclusionPROFILE OF A LEADING HEALTHCARE ECONOMIST: HEIDI WILLIAMSKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SET: machine-learning models for predicting drug approvalsREFERENCES12 Biotech Venture CapitalPROFILE OF A LEADING SCIENTIST/ENTREPRENEUR: PHILLIP SHARP12.1 What Is Venture Capital?PROFILE OF A LEADING SCIENTIST/ENTREPRENEUR: ROBERT S. LANGERPROFILE OF A LEADING SCIENTIST/ENTREPRENEUR: TILLMAN GERNGROSS12.2 Mitigating Risks and Aligning Goals: The Term Sheet12.2a Commitment of Capital12.2b Types of Securities12.2c Covenants12.2d Registration RightsPROFILES OF LEADING BIOPHARMA PROFESSIONALS: LUKE EVNIN AND ANSBERT GADICKE12.3 Raising Start-Up CapitalPROFILE OF A LEADING BIOPHARMA PROFESSIONAL: BRUCE BOOTH12.4 Biotech Valuation12.4a Determining Value Out: RevenuesPROFILE OF A LEADING HEALTHCARE ECONOMIST: MICHAEL GROSSMANPROFILE OF A LEADING HEALTHCARE ECONOMIST: JOSEPH A. DIMASI12.4b Determining Money In: Expenses12.4c Investment Time HorizonValuing Therapies for Rare Diseases12.4d Biotech Valuation Summary12.5 Venture PhilanthropyPROFILE OF A LEADING HEALTHCARE ECONOMIST: CAM DONALDSONThe Cystic Fibrosis Foundation and Venture PhilanthropyKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SET: axon bio case studyREFERENCES13 Securitizing Biomedical Assets13.1 What Is Securitization?13.2 A Numerical Example of Securitization13.3 Securitization and the Financial Crisis of 2007–200813.3a Numerical Example of Securitization Gone Wrong13.4 Biomedical MegafundsPROFILE OF A LEADING BIOPHARMA PROFESSIONAL: CHRISTIANA GOH BARDONPROFILE OF A LEADING BIOPHARMA PROFESSIONAL: NEIL KUMAR13.5 When Megafunds Don’t Work13.6 ConclusionKEY POINTSCONCEPT CHECK ANSWERSPROBLEM SET: orphan drug portfolio analysisREFERENCES14 Pricing, Value, and Ethics14.1 Price versus Value14.2 Ethics14.3 Evaluating Cost EffectivenessPROFILE OF A LEADING HEALTHCARE INSTITUTION: NATIONAL INSTITUTE FOR HEALTH AND CARE EXCELLENCE (NICE)14.4 Financing Health14.5 Can We Afford It?PROFILE OF A LEADING HEALTHCARE INSTITUTION: INSTITUTE FOR CLINICAL AND ECONOMIC REVIEW (ICER)14.6 Pricing Issues14.6a Drug Shortages14.6b Medical Device Shortages14.6c Drug Shortages Task Force14.7 Drug Manufacturer as Utility Company?PROFILE OF A LEADING HEALTHCARE POLICY EXPERT: PETER B. BACH14.8 Price Gouging versus Pricing for SurvivalPROFILE OF A LEADING HEALTHCARE ECONOMIST: KENNETH J. ARROWKEY POINTSCONCEPT CHECK ANSWERSREFERENCES15 Epilogue: A Case Study of Royalty PharmaPROFILE OF A LEADING BIOPHARMA PROFESSIONAL: PABLO LEGORRETAREFERENCESGlossaryIndex