Problem 13-19 Reward-to-Risk Ratios [LO4] Stock Y has a beta of 1.0 and an expec
ID: 2644932 • Letter: P
Question
Problem 13-19 Reward-to-Risk Ratios [LO4]
Stock Y has a beta of 1.0 and an expected return of 13.0 percent. Stock Z has a beta of 0.5 and an expected return of 7.8 percent. If the risk-free rate is 5.5 percent and the market risk premium is 6.5 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)overvaluedundervalued. (Round your answers to 2 decimal places. (e.g., 32.16))
Stock Y has a beta of 1.0 and an expected return of 13.0 percent. Stock Z has a beta of 0.5 and an expected return of 7.8 percent. If the risk-free rate is 5.5 percent and the market risk premium is 6.5 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)overvaluedundervalued. (Round your answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
Reward to risk
Y = (13% - 5.5%) / 1 = 7.5%
Z = (7.8% - 5.5%) / .5 = 4.6%
Stock Y reward to risk > market premium, therefore Stock Y has undervalued.
Stock Z reward to risk < market premium, therefore Stock Z has overvalued.