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. Capital Asset Pricing Model - CAPM

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

    The science that describes the management, creation and study ...
  4. Risk-Free Rate Of Return

    The theoretical rate of return of an investment with zero risk. ...
  5. Jensen's Measure

    A risk-adjusted performance measure that represents the average ...
  6. Compound Annual Growth Rate - CAGR

    The year-over-year growth rate of an investment over a specified ...
Related Articles
  1. 5 Things To Know About Asset Allocation
    Investing Basics

    5 Things To Know About Asset Allocation

  2. Introduction To Investment Diversification
    Investing Basics

    Introduction To Investment Diversification

  3. Cut Down Option Risk With Covered Calls
    Options & Futures

    Cut Down Option Risk With Covered Calls

  4. 5 Ways To Measure Mutual Fund Risk
    Mutual Funds & ETFs

    5 Ways To Measure Mutual Fund Risk

comments powered by Disqus
Hot Definitions
  1. Effective Annual Interest Rate

    An investment's annual rate of interest when compounding occurs more often than once a year. Calculated as the following: ...
  2. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  3. Odious Debt

    Money borrowed by one country from another country and then misappropriated by national rulers. A nation's debt becomes odious ...
  4. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the ...
  5. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by ...
  6. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
Trading Center