Stock Y has a beta of 1.5 and an expected return of 15.7 percent. Stock Z has a

Question

Stock Y has a beta of 1.5 and an expected return of 15.7 percent. Stock Z has a beta of 0.6 and an expected return of 8.2 percent. If the risk-free rate is 5.3 percent and the market risk premium is 6.3 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 undervalued and Stock Z is overvalued.

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Stock Y has a beta of 1.5 and an expected return of 15.7 percent. Stock Z has a beta of 0.6 and an expected return of 8.2 percent. If the risk-free rate is 5.3 percent and the market risk premium is 6.3 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 undervalued and Stock Z is overvalued.

Please show the steps

Explanation / Answer

Reward-Risk = (E(Ri)-Rf)/beta

Reward-Risk(Y) = (15.7-5.3)/1.5 = 6.933

Reward-Risk(Z) = (8.2-5.3)/0.6 = 4.833

Reward-Risk(SML) = (6.3)/1 = 6.3

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