Economics Risk And Return Questions Medium
The risk-adjusted return on investment capital is a measure that takes into account the level of risk associated with an investment and compares it to the potential return. It is used to evaluate the efficiency and profitability of an investment by considering the risk involved.
To calculate the risk-adjusted return on investment capital, one commonly used method is the Sharpe ratio. The Sharpe ratio is calculated by subtracting the risk-free rate of return from the investment's average return and dividing it by the standard deviation of the investment's returns. The risk-free rate of return is typically the return on a risk-free asset, such as a government bond.
A higher risk-adjusted return indicates that an investment has generated a higher return relative to the level of risk taken. This implies that the investment has been more efficient in generating returns compared to other investments with similar risk levels.
Investors and financial analysts use the risk-adjusted return on investment capital to compare different investment opportunities and make informed decisions. By considering the risk associated with an investment, they can assess whether the potential return justifies the level of risk taken. This measure helps in evaluating the trade-off between risk and return and assists in making optimal investment choices.