Advanced Diploma of Financial Planning (ADFP) Practice Test

What characterizes defensive stocks?

1. Stocks that do exceptionally well in a recession

2. Stocks that are affected predominantly by economic fluctuations

3. Stocks that tend to perform consistently regardless of economic conditions

4. Stocks that are highly speculative

The correct answer is: Stocks that tend to perform consistently regardless of economic conditions

Defensive stocks are characterized by their ability to provide consistent performance regardless of the economic conditions. These types of stocks typically belong to companies that offer essential goods and services, such as utilities, healthcare, and consumer staples. Because these industries tend to remain stable even during economic downturns, investors view them as safer bets during uncertain times. When economic conditions weaken, consumers still require essential products and services, which contributes to the steady revenue streams of these companies. This consistency in performance makes defensive stocks attractive to risk-averse investors, especially in periods of economic turbulence. In contrast, stocks that are affected predominantly by economic fluctuations may see significant changes in performance based on the economic cycle, while highly speculative stocks carry greater risks and potential for loss, making them less stable. As for stocks that do exceptionally well in a recession, they may not have the same steady performance in non-recession periods, thus differing from the defining characteristic of defensive stocks.