AAFM Professional Knowledge 3 — Questions and Answers
Question 1: Which valuation method discounts a company's expected future cash flows to present value?
- Discounted cash flow (DCF) (Correct answer)
- Book value method
- Liquidation value
- Replacement cost
Correct answer: Discounted cash flow (DCF)
DCF estimates intrinsic value by discounting projected cash flows at an appropriate rate.
Question 2: In estate planning, what is the main advantage of establishing a revocable living trust?
- Avoiding probate on transferred assets (Correct answer)
- Eliminating all estate taxes
- Guaranteeing higher investment returns
- Removing the need for a will
Correct answer: Avoiding probate on transferred assets
Assets held in a revocable trust pass to beneficiaries without going through probate.
Question 3: A bond's price will generally do what when market interest rates rise?
- Fall (Correct answer)
- Rise
- Stay unchanged
- Double
Correct answer: Fall
Bond prices move inversely to interest rates, so rising rates push existing bond prices down.
Question 4: What does the Sharpe ratio measure?
- Risk-adjusted return per unit of total risk (Correct answer)
- Absolute return only
- A stock's dividend yield
- Market capitalization
Correct answer: Risk-adjusted return per unit of total risk
The Sharpe ratio divides excess return by standard deviation to gauge return earned per unit of risk.
Question 5: Which retirement account allows qualified withdrawals to be tax-free in the U.S.?
- Roth IRA (Correct answer)
- Traditional IRA
- 401(k) with pre-tax contributions
- SEP IRA
Correct answer: Roth IRA
Roth IRA contributions are made after tax, so qualified withdrawals of contributions and earnings are tax-free.
Question 6: The 'efficient frontier' in portfolio theory represents portfolios that offer what?
- Maximum expected return for a given level of risk (Correct answer)
- The lowest possible cost
- Zero risk
- The highest dividends
Correct answer: Maximum expected return for a given level of risk
The efficient frontier plots optimal portfolios maximizing return for each risk level.
Question 7: What is the primary benefit of dollar-cost averaging?
- Reducing the impact of market volatility over time (Correct answer)
- Guaranteeing a profit
- Eliminating investment fees
- Timing the market perfectly
Correct answer: Reducing the impact of market volatility over time
Investing fixed amounts regularly buys more shares when prices are low and fewer when high, smoothing cost.
AAFM Professional Knowledge 3
Which valuation method discounts a company's expected future cash flows to present value?