Stock Y has a beta of 1.6 and an expected return of 16.6 percent. Stock Z has a

Question

Stock Y has a beta of 1.6 and an expected return of 16.6 percent. Stock Z has a beta of .8 and an expected return of 9.4 percent. If the risk-free rate is 5.1 percent and the market risk premium is 6.6 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.)

Stock Y has a beta of 1.6 and an expected return of 16.6 percent. Stock Z has a beta of .8 and an expected return of 9.4 percent. If the risk-free rate is 5.1 percent and the market risk premium is 6.6 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

Expected Return on Stock Y = 16.6%

Required retutrn on Y (Using CAPM) = 15.66%

Since required return using CAPM is less than expected return, Stock Y is Overvalued

Expected Return on Stock Z = 9.4%

Required retutrn on Z (Using CAPM) = 10.38%

Since required return using CAPM is less than expected return, Stock Z is Undervalued

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