Respuesta :
Answer:
Stock Y is undervalued because the reward-to-risk ratio for Stock Y is higher than the SML
Stock Z is overvalued because the reward-to-risk ratio for Stock Z is lower than the SML
Explanation:
From the question,
It is given:
FOR STOCK Y
Stock expected return = 14.7%
Stock beta = 1.4
risk-free rate is 5.2%
The Reward-to-risk ratio is given by the difference between the stock expected return and risk free rate divided by the stock beta.
Therefore
Reward-to-risk ratio for stock Y = (14.7% - 5.2%)/1.4
= 6.79%
FOR STOCK Z
Stock expected return = 8.7%
Stock beta = 0.7
risk-free rate is 5.2%
Therefore
Reward-to-risk ratio for stock Z = (8.7% - 5.2%)/0.7
= 5%
FOR SML
market risk premium = 6.2%
Risk rate = 5.2
Therefore
Reward-to-risk ratio for SML = (6.2%)/6.2 - 5.2
= 6.20%
Stock Y is undervalued because the reward-to-risk ratio for Stock Y is higher than the SML
Stock Z is overvalued because the reward-to-risk ratio for Stock Z is lower than the SML
Answer:
Reward to risk
Stock Y = 6.28%
Stock Z = 5%
SML = 6.2%
Stock Y is Undervalued
Stock Z is overvalued
Explanation:
In order to calculate the reward to risk ratio we need the reward/ER of stock and the risk
Stock Y = β 1.4, ER 14.7%
Stock Z = β 0.7 , ER 8.7%
rf = 5.2% rmp =6.2%
Reward to Risk Ratio
For Y
=(14.7-5.2)/1.4 =0.0628/6.28%
For Z
=(8.7-5.2)/0.7 =0.05/5%
SML is the reward to risk ratio of the market we are given market risk premium of the market and we know that the beta of market is 1
(6.2)/1=6.2%
The reward-to-risk ratio for Stock Y is higher than the market reward-to-risk ratio, meaning which the stock plots above the SML, and the stock is undervalued.
The reward-to-risk ratio for Stock Z is lower than the market reward-to-risk ratio, meaning which the stock plots above the SML, and the stock is overvalued.
The prices of these stocks must increase/ decrease until they equal Reward-to-risk of the market
