Economics Risk And Return Questions Medium
The risk-adjusted return on total capital is a measure that takes into account the level of risk associated with an investment or business activity in relation to the return generated. It is used to assess the efficiency and profitability of an investment by considering the risk involved.
To calculate the risk-adjusted return on total capital, one commonly used method is the risk-adjusted return on capital (RAROC) formula. This formula compares the expected return on an investment to the amount of capital required to generate that return, adjusted for the level of risk.
The formula for RAROC is as follows:
RAROC = (Expected Return - Risk-Free Rate) / Risk-Adjusted Capital
In this formula, the expected return is the anticipated profit or return from the investment, the risk-free rate is the rate of return on a risk-free investment such as government bonds, and the risk-adjusted capital is the amount of capital allocated to the investment, adjusted for the level of risk.
The risk-adjusted return on total capital provides a more accurate assessment of the profitability of an investment by considering the risk involved. It allows investors and businesses to compare different investment opportunities and make informed decisions based on the potential return and risk associated with each option.