Reading 37: Security Market Indices Flashcards
Identify the 2 versions of a security market index.
A price return index only reflects the prices of constituent securities.
A total return index not only reflects prices, but also assumes reinvestment of all income received since inception.
Define market float.
Market float generally refers to the number of shares of the constituent security that are available to the investing public. Shares held by controlling shareholders, other corporations, and governments are subtracted from the total number of outstanding shares to determine the market float.
Describe hedge fund indices.
Hedge fund indices are designed to represent the performance of hedge funds (private investment vehicles that typically use leverage and long and short investment strategies) on a very broad, global level or the strategy level.
How are indices used in the field of performance evaluation?
As benchmarks for actively managed portfolios
Identify the challenges of creating bond-market indices.
There is a broader universe of bonds than of stocks.
The universe of bonds is constantly changing as a result of new issues, calls, and maturities.
The price volatility of a bond (as measured by duration) is constantly changing. Duration changes with a bond’s maturity and market yields.
Current and continuous transaction prices are not available for bonds.
Give the formula used to calculate the value of a price return index.
VPRI=∑ni=1niPi/D
where:
VPRI = Value of the price return index ni = Number of units of constituent security i held in the index portfolio N = Number of constituent securities in the index Pi = Unit price of constituent security i D = Value of the divisor
Give the formula used to calculate weights in an equal-weighted index. What is the disadvantage in this formula?
wEi=1/N
where:
wi = Fraction of the portfolio that is allocated to security i or weight of security i
N = Number of securities in the index
The disadvantage of this formula is assigning an equal weight to all securities of the target market.
The index does not remain equally weighted once the prices of the constituent securities change. Frequent adjustments must be made to maintain equal weighting.
Give the formula used to calculate the total return of an index.
TRI= VPRI1 − VPRI0 + IncI /VPRI0
where:
TRI = Total return of the index portfolio (as a decimal number) VPRI1 = Value of the total return index at the end of the period VPRI0 = Value of the total return index at the beginning of the period IncI = Total income from all securities in the index held over the period
How may fixed-income indices be categorized?
Aggregate or broad market indices.
Market sector indices.
Style indices.
Economic sector indices.
Specialized indices such as high-yield, inflation-linked, and emerging market indices.
List and describe the types of equity indices.
Broad market: Contain securities representing > 90% of the selected market
Multi-market: Consist of security market indices from different countries; represent multiple national markets, geographic regions, economic development groups, or entire world
Sector: Include securities representing a particular economic sector that may be classified on a national, regional, or global basis
Style: Include those based on size or style; stocks may need to be reclassified over time based on changing valuation ratios or market capitalizations
Define reconstitution and identify the reasons why index reconstitution is performed.
Reconstitution refers to the process of changing the constituent securities in an index. Constituent securities need to be examined on a regular basis to evaluate whether they still meet the criteria for inclusion in the index. If they no longer meet the criteria, they must be replaced with securities that do meet the criteria.
Reconstitution is done to reflect changes in the target market as a result of bankruptcies, de-listings, mergers, and so on. They will also reflect the judgment of the selection committee.
What is involved in constructing and managing a security market index?
Target market selection
Security selection
Index weighting
Rebalancing
Reconstitution
Identify the characteristics of a commodity index.
They do not have an obvious weighting method, so index providers create their own weighting methods, either weighted equally, on the basis of price, or have fixed weights determined by a committee.
Different weighting methods lead to different exposures to specific commodities, which result in very different risk and return profiles of commodity indices.
Their performance may differ from that of the underlying commodities because indices consist of futures contracts on commodities rather than the actual commodities.
Describe how equal-weighted indices are rebalanced.
Rebalancing an equal-weighted index requires reducing the weight of securities that have outperformed and increasing the weight of securities that have underperformed.
List the securities that may be included in a target market.
Asset class
Geographic region
The exchange on which the securities are traded
Other characteristics
