Answer: 5.55%

## Explanation This question involves a multifactor model (2-factor model) to calculate stock returns. The formula for the multifactor model is: $$R_{WK} = E(R_{WK}) + \beta_{GDP}F_{GDP} + \beta_I F_I$$ Where: - $E(R_{WK}) = 7\% = 0.07$ (expected stock return) - $\beta_{GDP} = 1.5$ (GDP factor beta) - $\beta_I = 2$ (Inflation factor beta) - $F_{GDP} = \text{Actual GDP} - \text{Expected GDP} = 3\% - 4.5\% = -1.5\% = -0.015$ - $F_I = \text{Actual Inflation} - \text{Expected Inflation} = 2.9\% - 2.5\% = 0.4\% = 0.004$ Now substituting the values: $$R_{WK} = 0.07 + 1.5(-0.015) + 2(0.004)$$ $$R_{WK} = 0.07 - 0.0225 + 0.008$$ $$R_{WK} = 0.0555 = 5.55\%$$ The calculation shows that the actual stock return is 5.55%, which is lower than the expected return of 7% due to the negative surprise in GDP growth (actual GDP of 3% was lower than expected 4.5%), which had a larger negative impact than the positive surprise in inflation.

Author: Tanishq Prabhu