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Equity Investments【Reading 48】Sample

When using a security market index to represent a market’s performance, the performance of that market over a period of time is best represented by:
A)
the percent change in the index value.
B)
the index value.
C)
the change in the index value.



Percentage changes in the value of a security market index over time represent the performance of the market, segment, or asset class from which the securities are chosen.

A security market index is best described as a:
A)
value used to adjust nominal security prices for the effects of inflation.
B)
directory of ticker symbols for the securities listed on a given market.
C)
group of securities selected to represent the performance of a security market.



A security market index is a group of securities (the constituent securities) designed to represent the performance of an asset class, security market, or market segment.

TOP

In one year, a security market index has the following quarterly price returns:
First quarter3%
Second quarter4%
Third quarter-2%
Fourth quarter5%

The price return for the year is closest to:
A)
10.2%.
B)
9.9%.
C)
10.0%



Return for the year = (1.03)(1.04)(0.98)(1.05) − 1 = 10.23%.

TOP

The measure of return on a security market index that includes any dividends or interest paid by the securities in the index is known as the:
A)
price return.
B)
total return.
C)
cash flow return.



The total return on a security market index includes cash flows from the securities (dividends and interest) as well as price changes.

TOP

The value of a total return index:
A)
may increase at either a faster or slower rate than the value of a price return index with the same constituent securities and weights.
B)
can be calculated by multiplying the beginning value by the geometrically linked series of periodic total returns.
C)
is determined by the price changes of the securities that constitute the index.



The value of a total return index can be calculated by multiplying the beginning value by the geometrically linked series of index total returns. The value of a total return index includes both the price changes of the securities that constitute the index and any cash flows from the securities (dividends, interest, and other distributions). A total return index cannot increase at a slower rate (or decrease at a faster rate) than an otherwise identical price return index because cash flows from the securities cannot be negative.

TOP

An index provider maintains a price index and a total return index for the same 40 stocks. Assuming both indexes begin the year with the same value, the total return index at the end of the year will be:
A)
greater than the price index.
B)
less than the price index if the price index increases and greater than the price index if the price index decreases.
C)
equal to the price index if the constituent stocks do not pay dividends.



A price index only includes the prices of the constituent securities in the calculation of the index value. A total return index includes the prices and the dividends paid in the calculation of the index value. If all of the constituents are non-dividend paying stocks, then the total return index will be the same as the price index at the end of the year. Otherwise the total return index will be greater than the price index.

TOP

The value of a security market index at the end of December is 1,200. The index returns for the next six months are:
MonthReturn
January3.89%
February8.76%
March−4.74%
April6.88%
May−5.39%
June−8.12%

The index value at the end of June is closest to:
A)
1,200.
B)
1,186.
C)
1,214.



The index value at the end of June is
1,200(1.0389)(1.0876)(0.9526)(1.0688)(0.9461)(0.9188) = 1,200.
Note that the compound rate of return is
(1.0389)(1.0876)(0.9526)(1.0688)(0.9461)(0.9188)−1 = 0.

TOP

The first step in developing a security market index is choosing the index’s:
A)
target market.
B)
constituent securities.
C)
weighting method.



The first decision that must be made is choosing the target market the index will represent. Only then can the index provider determine which constituent securities should be included and which weighting scheme is most appropriate to measure the target market’s returns.

TOP

The target market for a security market index is best described as the:
A)
consumers who will purchase the licensing rights for the index.
B)
securities that are included in the index.
C)
market or segment the index is designed to measure.



The target market of an index is the securities market or portion of a securities market that the index will be designed to represent. The securities from the target market that are included in the index are called its constituent securities.

TOP

Assume a stock index consists of many firms who have recently split their stock. Which of the following weighting schemes will see a bias due to the impact of stock splits?
A)
Unweighted price series.
B)
Market value-weighted series.
C)
Price-weighted series.



Firms that split their stock price will have the identical weight before and after the split in both the unweighted and the market value-weighted series. However, in the price-weighted series, large successful firms will lose weight within the index due to simply splitting their stock. This creates a downward bias in a price-weighted series. Standard and Poor’s 500 Index is a market value-weighted index.

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