Risk and Rates of Return

Introduction

The North Central Utility (NGU) was created in 1996 by merging 2 energy companies, most of the managers of NGU were used to a monopolistic market without a lot of competition. Since the market was liberalized we as a consultant firm have make a risk analysis for the NGU management and familiarize them with a long term perspective.

Question 1

a) If we see a high spread between the high and the low return this does not necessarily mean that it is very risky, it is possible that a company has a small positive return in a recession and high positive return a boom period. Although we have a big spread we have a low risk because we don´t lose money neither in a boom nor in a recession. It is not very realistic but it shows that a big spread does not necessarily mean that it also has a high risk.

b) In the “good old days” the electric companies could plan their earnings very good and I think they would have a very constant return with a low volatility. I would expect a return like the T-bills, in a monopolistic market, because electricity is needed in a boom period but also in a recession period. Today with a higher competition and free markets the return is more volatile and the economic risks for the company are higher, the Food is good to compare because food is also needed in every situation and is market with competition.

c) Dividends are not really a sign of risk in the market, new firms normally invest all their money into their business and do not pay a lot of dividend but this does not meant that these companies are not risky while bigger companies normally pay a higher dividend. A chance in the dividend policy in a company is maybe an indicator for some chances in the future of the company and in this way maybe a bit of risk indicator, high dividends are also a sign that the price for the stock is too high and should be reduced with a high dividend.

d) T-bills are a very secure investment, and as we can see in the table they always have a...