The main purpose of this assessment is to analyze the business of airlines company and also analyze the returns of the business. The assessment would be analyzing the business of Fly Safely Limited and the same would also be comparing the return and profitability of the business with Always Reliable Limited. The assessment would also be considering the Beta of both the companies and effectively establish a relationship between risk and return of the business.
Background and Risk Profile of the Industry
The company which is considered for this assessment is Fly Safely Limited which is engaged in the business of providing air travel services to the business. The global market of airlines is immense which can be easily be estimated by the growth of such airline sector in different countries. An estimate suggests that there are 2000 airlines which are operating with more than 23000 aircrafts has increased significantly over the years (Kahneman and Tversky 2013). The company faces serious risks in the market as the cost of fuel is continuously on the rise and thereby the cost of production increases rapidly for such businesses. In addition to this, the overall competition in the market has also increased significantly over the years and this resulted in bankruptcy of 9 airlines businesses. The risks which is faced by such companies are high as in term of the regulations which are set about by government and regulating authorities. Therefore, it can be identified that airlines businesses face significant risks in market both from internal and external sources.
Risk and Return Theory
Returns are gains which are expected when an investment is undertaken by a business. The main reason for making investment in securities is due to enhance the wealth of the shareholders. The risks in an investment refers to the situation where a business can make losses from an investment. There are two types of risks in a business which are systematic and unsystematic risks which can affect a business (Bollerslev et al. 2013). There are also certain other kinds of risks such credit risks, liquidity risks. These risks must be considered by the business before taking any decision by the business and also needs to be analyzed by shareholders of the company.
In general terms, risk and returns of a security are positively related to each other. In other words, in case of a security if level of risk increases so does the overall return of the business (Du et al. 2015). The same needs to be considered in the case of Fly Safely Limited and Always Reliable Limited in order to reveal which company has a better management system and also accesses the risk.
Relevance of Beta (B)
The Beta which is considered signifies the risks in the investment and also reflects the volatility of the stocks of the business. The Beta (B) of a stock reflect the volatility of stocks in the market and an estimate of Beta which is greater than 1 is considered to be a risky stock. In the case of Fly Safely Limited, the beta is shown to be 1.43 which is considerably high and, on the basis, such beta appropriate decisions are to be taken by the investors of the business. The beta value which is shown in the case of Always Reliable is shown to be less than 1 which shows that the stock is less volatile in comparison to stocks of Fly Safely Limited.
Risk and Return Relation
In the case of Fly Safely Limited, the period which is considered is for 6 years and the return over the years is shown to be increasing year by year. The return of the business of Fly Safely limited shows there is fluctuation in the returns which is generated by the business and the return and the business is not able to generate regular basis of returns for the investors of the business (Iatridis 2015). Therefore, it can be said that the business of Fly Safely Limited is not able to meet the expectations of the shareholders appropriately. In the same situation, Always Reliable Limited which is also engaged in the same industry is able to generate appropriate returns and also consistent returns for the investors of the business (Baron et al. 2013). The risk in case of Fly Safely Limited is much more in comparison to the risks which is faced by Always Reliable Limited but the return for the latter is shown to be higher than Fly Safely Limited. This shows that the higher risk in the business of Fly Safely Limited is not bringing about more returns for the business. Therefore, there exists a mixed result where higher risk is leading to rise in returns for one year and then a fall in returns of the business.
Relationship between Cost of Debt and Company Risks
Cost of Debt refers to the use of debt capital and the interest paid which is paid by the business on the debt capital which is used by business. The computation of cost of debt of the business shows debt of the business. The risks in a business increases as the debt of the business increases as the business is under the pressure of interest burden of the debt taken by the business (Cavenaile, Gengenbach and Palm 2014). Therefore, if the business of Fly Safely Limited utilizes debt capital in the capital mix, the risks of the business would enhance.
As per the above discussion, the business of Fly Safely Limited needs to formulate a proper risk management strategy for managing the credit risk of securities. The management needs to reduce the Beta of the business and properly restructure the capital structure of the business in order to reduce the risks of the business. The analysis also shows that the risk and return of Always Reliable limited is better than Fly Safely Limited and therefore improvement needs to be made by the business of Fly Safely Limited in order to reduce the overall risks of the business.
Baron, M., Brogaard, J., Hagströmer, B. and Kirilenko, A., 2017. Risk and return in high-frequency trading.
Bollerslev, T., Osterrieder, D., Sizova, N. and Tauchen, G., 2013. Risk and return: Long-run relations, fractional cointegration, and return predictability. Journal of Financial Economics, 108(2), pp.409-424.
Cavenaile, L., Gengenbach, C. and Palm, F., 2014. Stock markets, banks and long run economic growth: a panel cointegration-based analysis. De Economist, 162(1), pp.19-40.
Du, T., Xiong, L., Xu, C.Y., Gippel, C.J., Guo, S. and Liu, P., 2015. Return period and risk analysis of nonstationary low-flow series under climate change. Journal of Hydrology, 527, pp.234-250.
Iatridis, G.E., 2015. Corporate philanthropy in the US stock market: Evidence on corporate governance, value relevance and earnings manipulation. International Review of Financial Analysis, 39, pp.113-126.
Kahneman, D. and Tversky, A., 2013. Prospect theory: An analysis of decision under risk. In Handbook of the fundamentals of financial decision making: Part I (pp. 99-127).