Stock Y has a beta of 1.2 and an expected return of 13.7 percent. Stock Z has a

Question

Stock Y has a beta of 1.2 and an expected return of 13.7 percent. Stock Z has a beta of .8 and an expected return of 9.5 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 1.2 and an expected return of 13.7 percent. Stock Z has a beta of .8 and an expected return of 9.5 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

Explanation / Answer

Step1: Computation of the reward to risk ratio.We have,

For stock Y:

Reward to risk ratio = (Expected return - Risk-free return) / Beta

Reward to risk ratio = (13.7 - 5.3) / 1.2 = 7.00%

For Stock Z:

Reward to risk ratio = (9.5 - 5.3 ) / 0.8 = 5.25%

Step2: Computation of the SML reward to risk.We have,

The SML reward-to-risk ratio is equal to the market risk premium. So, the SML reward-to-risk ratio is 6.3%

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