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 .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. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Stock Y has a beta of 1.5 and an expected return of 15.7 percent. Stock Z has a beta of .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. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Reward to risk ratio = (Expected return – Rf)/ beta

Reward to risk ratio (Y) = ( 0.1570-0.053)/1.50

                                                = 0.06933

                                                = 6.93%

Reward to risk ratio (Z) = (0.082-0.053)/0.60

                                                = 0.04833

                                                = 4.83%

SML reward to risk ratio = MRP

                                                = 0.063

                                                = 6.30%

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