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.

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. Sortino Ratio

    A modification of the Sharpe ratio that differentiates harmful ...
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. Mutual Funds & ETFs

    The ABCs of Mutual Fund Classes

    There are three main mutual fund classes, and each charges fees in a different way.
  8. Investing Basics

    5 Common Mistakes Young Investors Make

    Missteps are common whenever you’re learning something new. But in investing, missteps can have serious financial consequences.
  9. Mutual Funds & ETFs

    The 4 Best American Funds for Growth Investors in 2016

    Discover four excellent growth funds from American Funds, one of the country's premier mutual fund families with a history of consistent returns.
  10. Products and Investments

    A Guide to DIY Portfolio Management

    These are some of the pillars needed to build a DIY portfolio.
RELATED FAQS
  1. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  2. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>
Hot Definitions
  1. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  2. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  3. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  4. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  5. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center