Stock Y has a beta of 1.8 and an expected return of 18.3 percent. Stock Z has a

Question

Stock Y has a beta of 1.8 and an expected return of 18.3 percent. Stock Z has a beta of 1.0 and an expected return of 11.3 percent. If the risk-free rate is 5.6 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 and round your answers to 2 decimal places. (e.g., 32.16))

References

Stock Y has a beta of 1.8 and an expected return of 18.3 percent. Stock Z has a beta of 1.0 and an expected return of 11.3 percent. If the risk-free rate is 5.6 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 and round your answers to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Reward-to-risk ratio for Y=(18.3%-5.6%)/1.8=0.0706

Reward-to-risk ratio for Z=(11.3%-5.6%)/1.0=0.0570

Reward-to-risk ratio for Market=(6.6%)/1.0=0.0660

now Reward-to-risk ratio for Y is higher than Reward-to-risk ratio for Market , which means the stock Y will plot above the SML that means stock is undervalued.

now Reward-to-risk ratio for Z is lower than Reward-to-risk ratio for Market , which means the stock Z will plot below the SML that means stock is overvalued.

the above are the answers

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