G. describe uses of security market indices;

Question 1

Indexes are used for the following purposes:

Answer 1

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

• Analysts use indices to characterize
past performance, often for the
purpose of evaluating past
performance of active managers.
– “Index benchmarks”
• Analysts use indices to measuring and
model returns and systematic risk, and
to estimate risk-adjusted performance
– Analysts use indices to represent asset
classes in asset allocation models.

• Indices also serve as the basis for
various passive investment strategies
such as index funds and ETFs.
– The indices imply model portfolios that
produce returns equal to the returns to the
index.

The most appropriate benchmark for measuring the relative performance of an investment manager is: an index that closely matches the manager’s investment approach.

An index chosen as a benchmark for an investment manager’s performance should include securities in the manager’s investment universe. For example, the performance of an emerging market bond fund manager should be measured relative to the performance of an emerging market bond index.

An analyst using the capital asset pricing model is most likely to use a security market index as a proxy for:the market return.

The return on a security market index can be used as a proxy for the market return in a pricing model such as the CAPM.