The reward-to-risk ratio for Stock A is less than the reward-to-risk ratio of Stock B. Stock A has a beta of .82 and Stock B has a beta of 1.29. This information implies that:
A) Stock A is riskier than Stock B and both stocks are fairly priced.
B) Stock A is less risky than Stock B and both stocks are fairly priced.
C) either Stock A is underpriced or Stock B is overpriced or both.
D) either Stock A is overpriced or Stock B is underpriced or both.
E) both Stock A and Stock B are correctly priced since Stock A is less risky than Stock B.

Question

Quizplus · Accepted Answer

The reward-to-risk ratio, often measured against the market or a benchmark, indicates how much return an investment generates for each unit of risk. A lower ratio for Stock A compared to Stock B, combined with Stock A having a lower beta (indicating lower volatility or risk compared to the market), suggests that Stock A's pricing might be too high (overpriced) for its risk level, or Stock B might be offering more return for its risk level, potentially being underpriced. This discrepancy in reward-to-risk ratios and beta values implies a mispricing, leading to the conclusion that either Stock A is overpriced, Stock B is underpriced, or both.

The Reward-To-Risk Ratio for Stock a Is Less Than the Reward-To-Risk