As a security analyst for the Paris branch of Morgan Stanley Dean Wit- ter, you've identified the following factors and factor sensitivities for Elf Acquitaine (‘‘Elf''):
E(r) = µ + βProdFProd + βOilFOil + βTermFTerm + βRiskFRisk + βSpotFSpot
Elf's functional currency is the euro. Factors and factor sensitivities in euros are as follows:
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Factors
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Betas
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FProd
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change in world industrial production
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βProd = +1.10
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Foil
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change in crude oil prices
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βOil = +0.60
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FTerm
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long minus short government bonds
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βTerm = -0.05
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FRisk
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corporate minus government bonds
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βRisk = -0.10
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FSpot
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change in the euro value of a basket of foreign
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βSpot = -0.02
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currencies (s /f) with which Elf trades
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Elf's expected return is µ = 12 percent if all factors are equal to their expectation.
a. State whether Elf's shares are likely to go up or down with an increase in world industrial production, crude oil prices, the slope of the term structure, the risk premium, or the euro?
b. Given these parameters, what is the expected return on Elf stock in a year when each factor is 10 percent higher than its expectation?
c. If Elf stock falls by 12 percent during this period, by how much does Elf over- or underperform its expectation given each of the factors was 10 percent higher than its expectation during the period?