Assume that a stock'??s returns are affected by two factors: surprises in inflation and surprises in GDP growth: R = 8% - 0.5 F_infl + 1.25F_GDP + ε

Suppose the error term is 0.6%. If inflation was expected to be 2% but it'??s actually 2.5%, and the GDP surprises is 0%, what should be the return on the stock?

A. 8%
B. 8.25%
C. 8.35%

Correct Answer: C

8% - 0.5 x 0.5% + 0.6% = 8.35%