Question

What is RAROC? How does maximizing RAROC differ from maximizing ROE?

Answer 1

Answer-

Return on risk adjusted capital (RORAC) is a modified return on investment and it measure and  emphasizes on the total risk of the project. it takes ino consderation the expeted losses and the income that is generated and requires higher expected returns when riskier projects are undertaken.

The RORAC is generally used by banks and other financial companies that lend loans to diffferent firms and industries.
The RORAC is calculated as the ratio of  revenue and income from capital less expenses and expected losses to capital.
The income from capital is evaluated by multipling capital charges and risk free rate.

The RORAC can be maximized by increasing revenue and income from capital and minimizing expenses and expected losses.

The ROE can be maximized by increasing debt in capital structure of increasing leverage, along with increasing profit margins like net profit margin ( net income / sales ) and operating margin ( EBIT / Sales) anfd improving the asset turnover ( sales / total assets ), paying dividends and lower taxes.