Jack has interest in buying Riskee, Inc. stock. Having taken Finance 2660, he remembered to use the capital asset pricing model (CAPM) as a way of determining the asset’s risk-return relationship. He asked his stockbroker for Riskee’s beta coefficient, and after some delay, he was given a number of 3.0. He then referred to some financial print media to determine return values for the S&P 500 (market) and the 30-year Treasury bond as 10.0% and 5.0%, respectively. Lastly, after interviewing the CFO at Riskee, he learned that based on Riskee’s expected increase in market share and improved operation efficiency, Riskee’s expected return is 12% per year. Although Jack was a good student at CSU and can probably solve his problem independently, he has sought your assistance in making this investment decision.

a) How does this relate to the security market line? (Show graphically)

b) Should Jack purchase shares of Riskee stock? Explain your decision with sound financial theory.

c) Has Riskee, Inc stock reached its equilibrium, long-run price? Why or why not?

Answer rating: 100% (QA)

a The Capital Asset Pricing Model CAPM relates to the Security Market Line SML which is a graphical representation of the expected returns of assets b... View the full answer