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.

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