Module 37.1: Index Weighting Methods Flashcards
What is a security market index? What do you called the securities included in an index?
used to represent the performance of an asset class, security market, or segment of the market.
constituents
How do you calculate an index return?
price index or return index.
price index - uses only prices of the constituent securities
return index - includes both prices and income from the constituent securities.
What is the formula for return of an index?
(1 + rate of return) * (1 + rate of return) - 1
What are the five decisions an index provider must make?
1) what is the target market the index is intended to measure
2) which securities from the target market should be included
3) how should the securities be weighted in the index
4) how often should the index be rebalanced
5) when should the selection and weighting of securities be re-examined?
What is a price-weighted index>?
simply the arithmetic average of the prices of the securities included in the index.
What are the advantages and disadvantages of a price weighted index?
advantage - simple to calculate
disadvantage - given a percentage change in the price of a high priced stock has as greater impact on the index value.
What is an equal weighted index? what are the pros and cons?
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.
pros - easy to calculate
cons - matching to index would have to be adjusted periodically as prices change so that the values of all securities are equal.
What is a market cap weighted index? what are the pros and cons?
weights based on market cap as a proportion of total market cap of all stocks in the index.
What is a float-adjusted market capitalization-weighted index?
What is free float?
constructed like a market cap weighted index, the weights however, are based on the proportionate value of each firms shares available to investors.
free float is narrower than float because it excludes foreign investors.
What is fundamental weighting?
weights based on firm fundamentals such as earnings dividends or cash flow.
What is the formula for price weighting?
sum of stock prices / number of stocks in index adjusted for splits
How do you calculate current index value using the market cap weighting method?
(current total market value of index stocks / base year total market value of index stocks) x base year index value (typically 100)
