Security Market Indexes

Question 1

Each index has two versions based on how the return is calculated. the two types are:

Answer 1

• price return index

- total return index

Question 2

Price return index

Answer 2

• measures only the percentage change in price of the securities within the index

Question 3

Total return index

Answer 3

• considers price change of securities in index and all income from dividends or interest

Question 4

5 factors when considering constructing a security index:

Answer 4

1. target market
2. security selection (large, small cap)
3. weight allocated to each security
4. index rebalancing
5. reconstitution

Question 5

4 types of index weighting

Answer 5

• price weighting
• equal weighting
• market-cap weighting
• fundamental weighting
• all 4 could be cal w/ price or total value return

Question 6

Price weighted index formula

Answer 6

= sum of stock prices / DIVISOR (# of stocks in index adjusted for splits)
**need to use this formula to find the BOP and EOP values

price return = EOP value - BOP value / BOP value

Dividend return = income (dividends) / BOP price

Total return = price return + dividend return

ie Dow Jones

Question 7

Advantages and limitations of Price Weighted indexes

Answer 7

• advantages: simplicity
• limitations: results in arbitrary weights for securities
  if the price of a security is high, it will receive a relatively high weight, even though its market cap might be low

Question 8

Equal Weight Index formula

Answer 8

= initial index value * (1 + (avg % change in prices / 100))

Avg change in prices: for each security find EOP - BOP / BOP then avg

price return = avg % change in prices

dividend return = income / BOP price
a. do for each stock and add up total / number of stocks

total return = price return + dividend return

Question 9

Advantages and limitations of equal weighting

Answer 9

• advantages: simplicity
• limitations: securities with large MC are underrepresented and securities with lowest MC are overrepresented

requires frequent rebalancing

Question 10

Market-cap weighted index

Answer 10

S&P500

• weight of a security =
  MC of security / total MC of all index securities
• MC index = current total MV of index stocks / base yr total MV of index stocks * base yr index value

initial index value = total MC of all securities / divisor
*if giving initial index value, solve for divisor

find final index value

dividend return = total dividents per sh / initial MC

total return = price return + dividend return

Question 11

Advantages and limitations of Market-cap weighted index

Answer 11

• advantages: constituent securities are correctly represented in proportion to their value in market
• limitations: large MC stocks can bias weight up or down.

Question 12

Fundamental weight index pros/cons

Answer 12

• pros: value tilt

- cons: does not consider MV and requires rebalancing