Risk Adjusted Return On Capital Calculator

Risk Adjusted Return On Capital Formula:

\[ RAROC = \frac{(Revenue - Expenses - Expected Loss + Income From Capital)}{Capital Cost} \]

Revenue:

Expenses:

Expected Loss:

Income From Capital:

Capital Cost:

Risk Adjusted Return On Capital (RAROC):

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1. What is Risk Adjusted Return On Capital?

Risk Adjusted Return On Capital (RAROC) is a modified return on investment (ROI) figure that takes elements of risk into account. It provides a more comprehensive assessment of performance by considering both returns and the risks taken to achieve those returns.

2. How Does the Calculator Work?

The calculator uses the RAROC formula:

\[ RAROC = \frac{(Revenue - Expenses - Expected Loss + Income From Capital)}{Capital Cost} \]

Where:

Revenue - Income from normal business activities
Expenses - Costs incurred in business operations
Expected Loss - Anticipated average loss over a specified period
Income From Capital - Income from capital charges multiplied by risk-free rate
Capital Cost - Fixed, one-time expenses for capital assets

Explanation: The formula adjusts returns by accounting for expected losses and capital costs, providing a risk-adjusted performance measure.

3. Importance of RAROC Calculation

Details: RAROC is crucial for financial institutions and businesses to evaluate performance while considering risk exposure. It helps in capital allocation, performance measurement, and risk management decisions.

4. Using the Calculator

Tips: Enter all monetary values in dollars. Capital Cost must be greater than zero. All values should be positive numbers representing the respective financial metrics.

5. Frequently Asked Questions (FAQ)

Q1: Why use RAROC instead of traditional ROI?
A: RAROC provides a more accurate performance measure by factoring in the risks taken to achieve returns, unlike traditional ROI which only considers returns.

Q2: What are typical RAROC values?
A: RAROC values vary by industry and risk profile. Generally, higher values indicate better risk-adjusted performance. Values above the cost of capital are considered favorable.

Q3: How is Expected Loss calculated?
A: Expected Loss is typically calculated as Probability of Default × Loss Given Default × Exposure at Default, though it can be estimated based on historical data.

Q4: What types of businesses use RAROC?
A: RAROC is primarily used by financial institutions, banks, insurance companies, and other risk-intensive businesses for performance measurement and capital allocation.

Q5: How does RAROC help in decision making?
A: RAROC helps businesses compare different investment opportunities, allocate capital efficiently, and ensure that returns adequately compensate for the risks taken.