D**. Compare the Diff. Weighting Methods used in Index Construction

Question 1

Price-Weighted Indices

Answer 1

Give greatest weight to high-priced
securities.
• The high-priced securities most
influence the returns to price-weighted
index.
• A portfolio that holds an equal number
of shares in each of the index
securities will have a value that is
proportional to the index value.

Question 2

Value-Weighted Indices

Answer 2

• Give greatest weight to large cap
securities.
• The largest securities most influence the
returns to value-weighted index.
• A portfolio that holds an equal percentage
of the shares outstanding in each of the
index securities will have a value that is
proportional to the index value.
– The portfolio weights are equal to the index
value weights.

Question 3

Equal-Weighted Indices

Answer 3

• Give greatest weight to the most common
securities, which in most broad-based
universes are the small securities.
• The most numerous—typically the
smallest securities—most influence the
returns to equal-weighted indices.
• A portfolio that invests an equal dollar
amount in each of the index securities will
have a value that is proportional to the
index value.
– The portfolio must be rebalanced periodically
because security prices change.

Question 4

Fundamental-Weighted Indices

Answer 4

• Give greatest weight to the securities
with the highest fundamental values.
• If the fundamental value used is sales,
in comparison to a market
capitalization-weighted index, the
fundamental index will be tilted towards
value stocks
– Value companies generally have greater
sales than equal-sized growth companies.