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AAFM Financial Planning Principles Flashcards

6 cards from real AAFM practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.

Read the first 6 AAFM Financial Planning Principles flashcards as text

  1. What is the time value of money (TVM) concept?

    Answer: A dollar today is worth more than a dollar in the future due to its earning potential

    TVM recognizes that money available now can earn returns through investment, making it worth more than the same amount received in the future. This is foundational to present/future value calculations.

  2. What is Modern Portfolio Theory (MPT)?

    Answer: A framework for constructing diversified portfolios that maximize expected return for a given level of risk

    MPT, developed by Harry Markowitz, demonstrates that diversification can reduce portfolio risk without sacrificing returns by combining assets with different correlations, creating an 'efficient frontier' of optimal portfolios.

  3. What is the Capital Asset Pricing Model (CAPM)?

    Answer: A model relating expected return to systematic risk (beta), expressed as E(R) = Rf + β(Rm - Rf)

    CAPM calculates expected return based on the risk-free rate plus a risk premium determined by the asset's beta (sensitivity to market movements) multiplied by the market risk premium.

  4. What is asset allocation and why is it considered the most important investment decision?

    Answer: Dividing investments among asset classes (stocks, bonds, cash, alternatives) — research shows it determines about 90% of return variability

    Asset allocation strategically distributes investments across asset classes based on goals, time horizon, and risk tolerance. Studies show asset allocation explains approximately 90% of portfolio return variability over time.

  5. What is the efficient market hypothesis (EMH)?

    Answer: A theory stating that asset prices fully reflect all available information, making it impossible to consistently beat the market

    EMH (Eugene Fama) proposes three forms: weak (past prices reflected), semi-strong (all public information reflected), and strong (all information including insider knowledge reflected), each with different implications for investment strategy.

  6. What is the Sharpe Ratio and how is it used?

    Answer: A measure of risk-adjusted return calculated as (portfolio return - risk-free rate) / portfolio standard deviation

    The Sharpe Ratio measures excess return per unit of risk, allowing comparison of investments or portfolios on a risk-adjusted basis. Higher ratios indicate better risk-adjusted performance.