Advanced Diploma of Financial Planning (ADFP) Practice Test

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Prepare for the Advanced Diploma of Financial Planning Test. Study with interactive quizzes and comprehensive questions, each offering detailed explanations and insights. Gear up for success!

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Is it true that liquidity means selling an investment with a loss of principal?

True
False
Only in certain markets
Depends on the security

The correct answer is: False

Liquidity refers to the ease with which an asset can be converted into cash without significantly affecting its market price. When an investment is considered liquid, it means that you can quickly sell it in the market and receive cash relatively quickly and at or near its fair market value. The statement that liquidity means selling an investment with a loss of principal is not accurate. While it's possible for an investor to sell a liquid asset at a loss, particularly during times of market volatility, this is not a defining characteristic of liquidity itself. Instead, liquidity emphasizes the ability to sell quickly and efficiently rather than selling at a loss. Conversely, options that suggest it is true, or conditional (“only in certain markets” or “depends on the security”), imply situations where loss is inherent to liquidity, which is misleading. The defining aspect of liquidity focuses on the speed and efficiency of converting an investment into cash. Thus, indicating that liquidity inherently involves selling at a loss misrepresents the concept.