Stock Y has a beta of 1.4 and an expected return of 17.0 percent. Stock Z has a

Question

Stock Y has a beta of 1.4 and an expected return of 17.0 percent. Stock Z has a beta of 0.7 and an expected return of 10.1 percent. If the risk-free rate is 6.0 percent and the market risk premium is 7.2 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)overvaluedundervalued and Stock Z is (Click to select)undervaluedovervalued. (Round your answers to 2 decimal places. (e.g., 32.16))

Stock Y has a beta of 1.4 and an expected return of 17.0 percent. Stock Z has a beta of 0.7 and an expected return of 10.1 percent. If the risk-free rate is 6.0 percent and the market risk premium is 7.2 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)overvaluedundervalued and Stock Z is (Click to select)undervaluedovervalued. (Round your answers to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Reward-to-risk ratio of Stock Y = (17-6)/1.4 = 7.857

Reward-to-risk ratio of Stock Z = (10.1-6)/0.7 = 5.857

SML reward-to-risk ratio = 7.2

So,

Stock Y is undervalue and Stock Z is overvalued

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