Stock Y has a beta of 1 and an expected return of 13 percent. Stock Z has a beta

Question

Stock Y has a beta of 1 and an expected return of 13 percent. Stock Z has a beta of .5 and an expected return of 7.8 percent. If the risk-free rate is 5.5 percent and the market risk premium is 6.5 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)undervaluedovervalued and Stock Z is (Click to select)undervaluedovervalued. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

The reward-to-risk ratio for Stock Y is too high, which means the stock plots above the SML, and the stock is undervalued. Its price must increase until its reward-to-risk ratio is equal to the market reward-to-risk ratio

{## the question is incomplete as the reward to risk ratio values are misssing) so can't complete oin this basis So we can conclude on the basis of CAPM )

Decision on the basis of CAPM:

E(Ry) = 5.5 + 1*(6.5-5.5) = 6.5%

E(Rz) = 5.5 + 0.5*(6.5-5.5) = 6.0%

Given Expected Return Y = 13%

Given Expected Return Z = 7.8%

Stock Y & Z both are Undervalued on the vasis of CAPM Return.

Stock Y Stock Z Beta 1 0.5 return 13% 7.80% Rm-Rf 6.50% 6.50% Stock Reward to risk ratio = (Ry-Rf)/Beta (Rz-Rf)/Beta (0.13-0.055)/1 (0.078-0.055)/0.5 0.08 0.05 8% 5%

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