Advanced Diploma of Financial Planning (ADFP) Practice Test

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Excel in the Advanced Diploma of Financial Planning Test with comprehensive quizzes. Study with detailed questions, hints, and explanations. Prepare for success now!

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How do bond prices relate to interest rates?

They move in the same direction as interest rates.
They are not affected by interest rates.
They move inversely to interest rates.
They increase with higher interest rates.

The correct answer is: They move inversely to interest rates.

The relationship between bond prices and interest rates is characterized by an inverse correlation. When interest rates rise, newly issued bonds tend to offer higher yields to attract investors, making existing bonds with lower yields less attractive. As a result, the prices of existing bonds decrease to align with the higher yields being offered by new bonds. Conversely, when interest rates fall, existing bonds with higher yields become more valuable, leading to an increase in their prices. This dynamic plays a crucial role in how investors assess the attractiveness of bonds relative to other investment options. Understanding this inverse relationship is essential for making informed decisions about bond investments and navigating interest rate fluctuations in the financial markets.