Explanation

The ERP using the Grinold-Kroner model is closest to 4.3%.

Grinold-Kroner Model Formula: Expected Return = Dividend Yield + Expected Nominal Earnings Growth + Expected Repricing Return

Components:

• Dividend Yield = 2.4%
• Expected Repricing Return = Expected growth rate in P/E ratio = 1.2%
• Expected Nominal Earnings Growth = Real GDP growth rate + Expected inflation

Expected Inflation Calculation: Expected Inflation = 10-year Treasury bond yield - 10-year TIPS yield = 5.0% - 2.7% = 2.3%

Expected Nominal Earnings Growth: Real GDP growth rate + Expected inflation = 2.8% + 2.3% = 5.1%

Total Expected Return: 2.4% + 5.1% + 1.2% = 8.7%

Equity Risk Premium: Expected Return - Risk-free rate = 8.7% - 2.1% = 6.6%

Wait, this gives 6.6% which is close to Option B. Let me recalculate:

Actually, the correct Grinold-Kroner model is: Expected Return = Dividend Yield + Expected Inflation + Real Earnings Growth + Expected Repricing Return

Real Earnings Growth ≈ Real GDP growth rate = 2.8% Expected Inflation = 2.3% Expected Repricing Return = 1.2% Dividend Yield = 2.4%

Total Expected Return = 2.4% + 2.3% + 2.8% + 1.2% = 8.7% ERP = 8.7% - 2.1% = 6.6%

However, looking at the options, 6.6% is closest to 6.5% (Option B), not 4.3% (Option A). Let me check if I'm missing something.

Correction: The expected change in shares outstanding is 0.0%, so no adjustment needed. The calculation should be: Expected Return = 2.4% + 2.8% + 2.3% + 1.2% = 8.7% ERP = 8.7% - 2.1% = 6.6%

This is closest to 6.5% (Option B).

Final Answer: B