Risk Adjusted Return

Risk Adjusted Return is a term often used in determining how much return should be expected, based on the volatility of the given investment asset.  As this applies to purchasing a business, this expected return is calculated as the capitalization rate (the discount rate) that is used in the Discounted Cash Flow method of valuing a business.

As the concept is applied to Portfolio Management, this refers to measuring the risk versus the expected return of a given investment alternative. This is typically measured by the Sharpe ratio, which divides the excess of the expected asset return over the risk free rate of return by the standard deviation of the excess of the return. The higher the number the better.