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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What type of risk are investors typically trying to minimize by using bonds in their portfolios?

Market risk
Inflation risk
Credit risk
Interest rate risk

The correct answer is: Interest rate risk

Investors typically use bonds in their portfolios to minimize interest rate risk. This type of risk refers to the potential for investment losses due to changes in interest rates. When interest rates rise, bond prices generally fall, which can lead to losses for investors holding bonds. By including bonds in their portfolios, investors can stabilize their overall returns and reduce the impact of fluctuating interest rates. This is particularly true for more stable, long-term bonds that are less sensitive to interest rate hikes compared to shorter-term securities. While market risk, inflation risk, and credit risk are important considerations, the primary focus when using bonds in a portfolio context tends to revolve around managing exposure to interest rate changes. Bonds are often seen as a way to provide steady income and a degree of safety from the volatility associated with equities, making them an essential component in mitigating interest-related uncertainties.