The risk-free rate is currently 6 percent. Is one of the two securities overvalued relative to the other?

To answer, we compute the reward-to-risk ratio for both. For SWMS, this ratio is (14% -6%)/1.3 = 6.15%. For Insec, this ratio is 5 percent. What we conclude is that Insec offers an insufficient expected return for its level of risk, at least, relative to SWMS. Because its expected return is too low, its price is too high. In other words, Insec is overvalued relative to SWMS, and we would expect to see its price fall relative to SWMS's. Notice that we could also say SWMS is undervalued relative to Insec.

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