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FRM Part II · FRM Exam Part II · Factors

A two-factor macroeconomic model for a stock gives expected return = 6% + 1.5×(inflation surprise) − 2.0×(GDP surprise), with surprises measured in percentage points and applied to the return in percent per point. Forecasts: inflation 2.0%, GDP growth 3.0%. Actual inflation is 3.2% and actual GDP growth is 2.5%. The stock's actual return is 9.5%, and the residual is firm-specific. What is the firm-specific return?

The firm-specific return is 0.70%. The inflation surprise is +1.2 and the GDP surprise is −0.5, so the factor contribution is 1.8 plus 1.0, or 2.8%. Adding the 6% base gives 8.8%, and the actual 9.5% less 8.8% leaves 0.70%.

  1. A0.70%Correct
  2. B−0.70%
  3. C1.50%
  4. D−1.30%

Explanation

Inflation surprise = 3.2 − 2.0 = +1.2; GDP surprise = 2.5 − 3.0 = −0.5. Factor effect = 1.5×1.2 − 2.0×(−0.5) = 1.8 + 1.0 = 2.8. Model return = 6 + 2.8 = 8.8%. Firm-specific = 9.5 − 8.8 = 0.70%. Using actual levels rather than surprises gives wrong results.

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