Risk Adjusted Return on Capital

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Risk Adjusted Return on Capital

A measure of the profitability of an investment or business after accounting for its risk. This can help inform one's investment decisions. It is calculated as follows:

RAROC = ( revenue - expenses - expected loss + income from capital invested ) / capital

It should be noted that an investment's RAROC has become a less common measure than the risk adjusted return on risk adjusted capital (RARORAC).
References in periodicals archive ?
"Now some of them are beginning to move to using an actual RAROC model to say, 'What are the banks getting from us?'"
The RAROC value indicates the size of the rewards brought about by the loss of one unit of capital, and effectively measures the efficiency of the risk of earning revenue; therefore, the bigger the value the better.
It is proposed for settling these issues the development of a model that will measure trade credit extension profitability adjusted to credit risk and, to this end, the Theory of Restriction (TOC) profitability concept and RAROC model (Risk-Adjusted Return on Capital) will be adopted for its calculation.
While transactions in the past were based on a company's appetite for risk and that appetite alone, banks have started to move toward an environment where concerns about risk adjusted return on capital (RAROC) figure more heavily into lending decisions, meaning that banks are becoming more concerned not just with the volume, but with optimizing the return on risky investments and using allocated capital more efficiently.
As opposed to mentioning ultimate objectives, such as estimating enterprise-wide RAROC by relationship and line of business, it is more useful to think in terms of lower-level tactics.
Most recently, industry leaders have begun to take a more holistic view of risk, capital and return by implementing enterprise-risk models based on methodologies such as dynamic financial analysis (DFA), value at risk (VaR) and risk-adjusted return on capital (RAROC), reports Risk Management Solutions, Newark, Calif., a leading provider of catastrophe models.
Risk adjusted return on capital (RAROC)--a measure of profitability of a business activity based on whether its return on capital is above or below its equity hurdle rate--is 20 percent.
With respect to market risks, methodologies such as Bankers Trust's RAROC and J.P.
Compensation, including bonuses, should be linked to a meaningful bottom-line measure such as risk-adjusted return on capital (RAROC).
Proponents of RAROC (risk-adjusted rerum on capital) and similar mechanisms argue that, on correctly risk-adjusted bases, tier two capital levels generally should be around 5 percent.