Risk-Adjusted Return On Capital - RAROC

AAA

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

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  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. Net Line

    The amount of risk that an insurance company retains after subtracting ...
RELATED FAQS
  1. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  2. What percentage of a diversified portfolio should large cap stocks comprise?

    The percentage of a diversified investment portfolio that should consist of large-cap stocks depends on an individual investor's ... Read Full Answer >>
  3. What are the alert zones in a Fibonacci retracement?

    The most commonly used Fibonacci retracement alert levels are at 38.2% and 61.8%. A 50% retracement level is also commonly ... Read Full Answer >>
  4. How was the Fibonacci retracement developed for use in finance?

    The use of Fibonacci retracements in stock trading was popularized by noted technical analysts W.D. Gann and R.N. Elliott. ... Read Full Answer >>
  5. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  6. Why should an investor include an allocation to the telecommunications sector in ...

    An investor should include an allocation to the telecommunications sector in his portfolio, because telecom offers an investor ... Read Full Answer >>
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. Investing

    The Number One Reason Why Most Traders Fail

    We show you the simple tools, availble to everyone, to succeed as an active trader: education, experience, charts, vision, and risk management systems.
  8. Fundamental Analysis

    20-Year Treasury Bond ETF Trading Strategies

    iShares 20-Year Treasury Bond ETF offers a highly liquid equity alternative to direct bond exposure.
  9. Technical Indicators

    How To Interpret The Volume Zone Oscillator

    Introduced in 2009, the Volume Zone Oscillator (VZO) is gaining traction with traders and technicians.
  10. Trading Strategies

    Uncovering Evidence Of Sector Rotation

    Stalk ETF performance lists over several weeks to uncover hidden institutional buying and selling strategies.

You May Also Like

Hot Definitions
  1. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  2. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  3. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  4. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  5. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
  6. Touchline

    The highest price that a buyer of a particular security is willing to pay and the lowest price at which a seller is willing ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!