Stock Y has a beta of 1.05 and an expected return of 15.55 percent. Stock Z has

Question

Stock Y has a beta of 1.05 and an expected return of 15.55 percent. Stock Z has a beta of .90 and an expected return of 6 percent. If the risk-free rate is 4.0 percent and the market risk premium is 8.8 percent, what are the reward-to-risk ratios of Y and Z? (Do not round intermediate calculations. Round your answers to 4 decimal places.)

Reward to risk ratio for stock Y:

= (15.55%-4%)÷1.05

= 11

Reward to risk ratio for stock Z:

= (6%-4%)÷0.9

= 2.22

Was told this was the answer but it is not correct!

Explanation / Answer

We need to c

We need to calculate using CAPM approach

For Stock Y

Rate of return of Y = 4 +1.05*8.8 = 13.24% (As per CAPM, rate of return = Rf + beta *Rm where Rf =4%, Rm =8.8% and Beta =1.05)

Expected Return for Y is 15.55%

Hence reward risk ratio is 15.55/13.24 = 1.17

For Stock Z

Rate of return of Z = 4 +0.9*8.8 = 11.92% (As per CAPM, rate of return = Rf + beta *Rm where Rf =4%, Rm =8.8% and Beta =0.9)

Expected Return for Z is 6%

Hence reward risk ratio is 6/11.92 = 0.50

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