Economics Risk And Return Questions Medium
Risk-adjusted return is a measure used in finance to evaluate the return on an investment relative to the level of risk taken. It takes into account the amount of risk involved in an investment and compares it to the return generated. The concept of risk-adjusted return recognizes that investors are generally risk-averse and require compensation for taking on additional risk.
There are various methods to calculate risk-adjusted return, but one commonly used measure is the Sharpe ratio. The Sharpe ratio calculates the excess return of an investment (the return above the risk-free rate) per unit of risk taken (measured by the standard deviation of returns). A higher Sharpe ratio indicates a better risk-adjusted return, as it implies that the investment generated higher returns relative to the amount of risk taken.
Another measure of risk-adjusted return is the Treynor ratio, which also considers the excess return per unit of risk but uses beta as a measure of risk instead of standard deviation. The Treynor ratio is particularly useful for evaluating the performance of a portfolio in relation to systematic risk.
In summary, risk-adjusted return is a way to assess the performance of an investment by considering the level of risk taken. It helps investors compare different investment options and determine whether the return generated is sufficient given the amount of risk involved.