Economics Risk And Return Questions Medium
The risk-adjusted return on assets is calculated by dividing the excess return of an asset by its risk. The excess return is the difference between the actual return of the asset and the risk-free rate of return. The risk is typically measured by the asset's standard deviation or beta, which represents its sensitivity to market movements.
The formula for calculating the risk-adjusted return on assets is as follows:
Risk-Adjusted Return on Assets = (Actual Return - Risk-Free Rate) / Risk
For example, let's say an asset has an actual return of 10%, the risk-free rate is 3%, and the asset's standard deviation is 5%. The risk-adjusted return on assets would be:
Risk-Adjusted Return on Assets = (10% - 3%) / 5% = 1.4
This means that for every unit of risk taken on by investing in the asset, the investor is earning a return of 1.4 units above the risk-free rate. The higher the risk-adjusted return on assets, the better the asset is performing relative to its risk.