Definition of raroc

Risk adjusted return on capital (raroc): A way of measuring profitability that takes into account the riskiness of an activity. Specifically, raroc is often measured as a ratio. On the top is the expected revenue from a project minus the expected expenses, the expected losses and return from investing the same amount of capital in something with no risks. The bottom of the ratio is the amount of capital the firm plans to use in the project. The idea was popularised by Bankers Trust in the late 1970s and 1980s and banks use it to help determine how to allocate their capital among different activities.

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