Question

Stock Y has a beta of 1.3 and an expected return of 15.3 percent. Stock Z has a beta of 0.70 and an expected return of 9.3 percent. If the risk-free rate is 5.5 percent and the market risk premium is 6.8 percent, the reward-to-risk ratios for stocks Y and Z are and percent, respectively. Since the SML reward-to-risk is percent, Stock Y is (Click to select) and Stock Z is:_______ . (Round your answers to 2 decimal places. (e.g., 32.16))

Answer 1

Answer:

Reward-to-risk ratio Y =7.54%

Reward-to-risk ratio Z = 5.43%

Since the SML reward-to-risk is 6.8%

Stock Y is Undervalued

Stock Z Overvalued

Explanation:

Calculation for the reward-to-risk ratios for stocks Y is 7.54% and Z is 5.43% respectively.

Reward-to-risk ratio Y = (15.3%-5.5%)/1.3

Reward-to-risk ratio Y =7.54%

Reward-to-risk ratio Z = (9.3%-5.5%)/0.7 =

Reward-to-risk ratio Z = 5.43%

Therefore the reward-to-risk ratios for stocks Y and Z are and percent, respectively

Since the SML reward-to-risk is 6.8%

Stock Y is undervalued while Stock Stock Z on the other hand is overvalued reason been that

Reward-to-risk ratio Y is high while the Reward-to-risk ratio is low .