Question

Check my Problem 13-18 Reward-to-Risk Ratios (L04) Stock Y has a bota 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 and enter your answers as a percent rounded to 2 decimal places, e..2.16.) < Prev 3 of 6 Next > re to search DELL

Answer 1

Reward to risk ratio formula = (Expected return of security-Risk free rate)/Beta of security      
stock Y Ratio =       (13.7%-5.3%)/1.2
7.00%      
      
Stock Z ratio =       (9.5%-5.3%)/0.8
      
5.25%      
      
SML reward to risk ratio = Market risk premium/Beta of Market      
      
beta of Market is always 1      
So SML reward to risk is 6.3%      
      
So stock Y has greater Sharpe ratio than SML, so it is undervalued      
Stock Z has lower Sharpe ratio than SML. so it is overvalued