Risk-Adjusted Return On Capital - RAROC


DEFINITION of 'Risk-Adjusted Return On Capital - RAROC'

An adjustment to the return on an investment that accounts for the element of risk. Risk-adjusted return on capital (RAROC) gives decision makers the ability to compare the returns on several different projects with varying risk levels. RAROC was popularized by Bankers Trust in the 1980s as an adjustment to simple return on capital (ROC).

Risk Adjusted Return on Capital (RAROC)

Income from capital = (capital charges)*(risk-free rate)
Expected loss = average anticipated loss over the measurement period

BREAKING DOWN 'Risk-Adjusted Return On Capital - RAROC'

In financial analysis, riskier projects and investments must be evaluated differently from their riskless counterparts. By discounting risky cash flows against less risky cash flows, RAROC accounts for changes in the profile of the investment. In general, the higher the risk, the higher the return. Thus, when companies need to compare and contrast two different projects or investments, it is important to take into account these possibilities.

  1. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
  2. Jensen's Measure

    A risk-adjusted performance measure that represents the average ...
  3. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  5. Finance

    The science that describes the management, creation and study ...
  6. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, ...
Related Articles
  1. Investing Basics

    5 Things To Know About Asset Allocation

    Overwhelmed by investment options? Learn how to create an asset allocation strategy that works for you.
  2. Investing Basics

    Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  3. Options & Futures

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
  4. Mutual Funds & ETFs

    5 Ways To Measure Mutual Fund Risk

    These statistical measurements highlight how to mitigate risk and increase rewards.
  5. Mutual Funds & ETFs

    Enhanced Index Funds: Can They Deliver Low-Risk Returns?

    These funds may look appealing. Find out whether they can really live up to all of their promises.
  6. Insurance

    The Dangers Of Over-Diversifying Your Portfolio

    If you diversify too much, you might not lose much, but you won't gain much either.
  7. Retirement

    Two Heads Are Better Than One With Your Finances

    We discuss the advantages of seeking professional help when it comes to managing our retirement account.
  8. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  9. Professionals

    A Day in the Life of a Hedge Fund Manager

    Learn what a typical early morning to late evening workday for a hedge fund manager consists of and looks like from beginning to end.
  10. Entrepreneurship

    Creating a Risk Management Plan for Your Small Business

    Learn how a complete risk management plan can minimize or eliminate your financial exposure through insurance and prevention solutions.
  1. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  2. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  3. Does mutual fund manager tenure matter?

    Mutual fund investors have numerous items to consider when selecting a fund, including investment style, sector focus, operating ... Read Full Answer >>
  4. Why do financial advisors dislike target-date funds?

    Financial advisors dislike target-date funds because these funds tend to charge high fees and have limited histories. It ... Read Full Answer >>
  5. Why are mutual funds subject to market risk?

    Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
  6. Why have mutual funds become so popular?

    Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center