Book 3_Equity_READING 42_SECURITY MARKET INDEXES

Question 1

A security market index

Answer 1

represents the performance of an asset class, security market, or segment of a market

Question 2

The performance of the market or segment over a period of time

Answer 2

is represented by the percentage change in (i.e., the return on) the value of the index.

Question 3

A price index

Answer 3

uses only the prices of the constituent securities in the return calculation

Question 4

A total return index

Answer 4

uses both the price of and the income from the index securities in the return calculation

Question 5

Decisions that index providers must make when constructing and managing indexes

Answer 5

• The target market the index will measure.
• Which securities from the target market to include.
• The appropriate weighting method.
• How frequently to rebalance the index to its target weights.
• How frequently to re-examine the selection and weighting of securities

Question 6

A price-weighted index

Answer 6

• The arithmetic mean of the prices of the index securities
• The divisor, which is initially equal to the number of securities in the index, must be adjusted for stock splits and changes in the composition of the index over time.

Question 7

An equal-weighted index

Answer 7

• is calculated as the arithmetic average return of the index stocks and, for a given time period, would be matched by the returns on a portfolio that had equal dollar amounts invested in each index stock
• assigns the same weight to each of its constituent securities.

Question 8

A market capitalization-weighted index

Answer 8

• Gives each constituent security a weight equal to its proportion of the total market value of all securities in the index.
• Market capitalization can be adjusted for a security’s market float or free float to reflect the fact that not all outstanding shares are available for purchase

Question 9

A fundamental-weighted index

Answer 9

uses weights that are independent of security prices, such as company earnings, revenue, assets, or cash flow.

Question 10

Price-weighted index

Answer 10

= sum of stock prices/number of stocks in index adjust for splits

Question 11

Market capitalization weighted index

Answer 11

= (current total market value of index stocks/base year total market value of index stock) x base year index value

Question 12

Equal-weighted index

Answer 12

= (1+ average percentage change in index stocks)x initial index value

Question 13

Index providers

Answer 13

• Periodically rebalance the weights of the constituent securities.
• This is most important for equal-weighted indexe

Question 14

Reconstitution

Answer 14

• Refers to changing the securities that are included in an index.
• This is necessary when securities mature or when they no longer have the required characteristics to be included.

Question 15

Indexes are used for the following purposes

Answer 15

• Reflection of market sentiment.
• Benchmark of manager performance.
• Measure of market return.
• Measure of beta and excess return.
• Model portfolio for index funds.

Question 16

Broad market equity indexes

Answer 16

represent the majority of stocks in a market.

Question 17

Multi-market equity indexes

Answer 17

• Contain the indexes of several countries.
• Multi-market equity indexes with fundamental weighting use market capitalization weighting for the securities within a country’s market but then weight the countries within the global index by a fundamental factor

Question 18

Sector indexes

Answer 18

• Measure the returns for a sector (e.g., health care) and
• Are useful because some sectors do better than others in certain business cycle phases.
• To evaluate portfolio managers and as models for sector investment funds.

Question 19

Style indexes

Answer 19

• Measure the returns to market capitalization and value or growth strategies.
• Stocks tend to migrate among classifications, which causes style indexes to have higher constituent turnover than broad market indexes

Question 20

Security market indexes available from commercial providers

Answer 20

represent a variety of asset classes and reflect target markets that can be classified by:
‘- Geographic location, such as country, regional, or global indexes.
- Sector or industry, such as indexes of energy producers.
- Level of economic development, such as emerging market indexes.
- Fundamental factors, such as indexes of value stocks or growth stocks.

Question 21

Fixed-income indexes

Answer 21

• Can be classified by issuer, collateral, coupon, maturity, credit risk (e.g., investment grade versus high-yield), and inflation protection
• Can be delineated as broad market, sector, style, or other specialized indexes. Indexes exist for various sectors, regions, and levels of development

Question 22

Issues in creating commodity indexes

Answer 22

• the weighting method (different indexes can have vastly different commodity weights and resulting risk and return)
• commodity indexes are based on the performance of commodity futures contracts, not the actual commodities, which can result in different performance for a commodity index versus the actual commodity.

Question 23

Real estate indexes

Answer 23

appraisal indexes, repeat property sales indexes, and indexes of real estate investment trusts

Question 24

Because hedge funds report their performance to index providers voluntarily

Answer 24

• The performance of different hedge fund indexes can vary substantially
• and index returns have an upward bias

Question 25

a price-weighted index return over a one-month period.

Answer 25

Index current period/Index base period - 1

Question 26

An equal-weighted index will be rebalanced most frequently

Answer 26

because as stock prices change, their representation in the index needs to be adjusted

Question 27

Most global security indexes

Answer 27

are market capitalization-weighted with a float adjustment to reflect the amount of shares available to investors.