Economics Risk And Return Questions Medium
The risk-adjusted internal rate of return (RAIRR) is a financial metric used to evaluate the profitability of an investment while taking into consideration the level of risk associated with it. It is a modification of the traditional internal rate of return (IRR) that adjusts for the riskiness of the investment.
The RAIIR incorporates the concept of risk by factoring in the expected return of a risk-free investment, such as a government bond, as a benchmark. This allows investors to compare the potential return of a risky investment with the guaranteed return of a risk-free investment.
To calculate the RAIIR, the expected return of the risk-free investment is subtracted from the expected return of the investment being evaluated. This difference is then divided by the standard deviation of the investment's returns, which measures the volatility or riskiness of the investment. The resulting ratio is added to the risk-free rate to obtain the RAIIR.
The RAIIR provides a more accurate measure of an investment's profitability by considering both the potential return and the associated risk. It helps investors make informed decisions by comparing investments on a risk-adjusted basis, allowing them to assess whether the potential return justifies the level of risk involved.