Gypsy

Which of the following weighting schemes will produce a downward bias on the index due to the occurrence of stock splits by firms in the index?

A) Price-weighted series.

B) Market-cap weighted series.

C) Equal weighted price indicator series.

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The price-weighting scheme sums the market price of each of the stocks contained in the index and then divides this sum by the number of stocks in the index. Thus if a firm executes a stock split thereby reducing its share price, this will cause a downward bias in the index.

Gypsy

Which of the following statements best describes the investment assumption used to calculate an equal weighted price indicator series?

A) An equal number of shares of each stock are used in the index.

B) An equal dollar investment is made in each stock in the index.

C) A proportionate market value investment is made for each stock in the index.

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An equal weighted price indicator series assumes that an equal dollar investment is made in each stock in the index. All stocks carry equal weight regardless of their price or market value.

Gypsy

In a market-capitalization weighted index firms with:

A) greater market caps have greater impacts on the index.

B) higher stock prices have greater impacts on the index.

C) larger market caps have lesser impacts on the index.

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In a value weighted index, firms with greater market caps have a greater impact on the index than firms with lower market caps. A higher stock price does not necessarily mean a higher market cap.

Gypsy

Which of the following statements about indexes is CORRECT?

A) A market weighted series must adjust the denominator to reflect stock splits in the sample over time.

B) An equal weighted index assumes a proportionate market value investment in each company in the index.

C) A price-weighted index assumes an equal number of shares (one of each stock) represented in the index.

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The descriptions of value weighted and unweighted indexes are switched. The denominator of a price-weighted index must be adjusted to reflect stock splits and changes in the sample over time. A market value-weighted series assumes you make a proportionate market value investment in each company in the index.

Gypsy

With regard to stock market indexes, it is least likely that:

A) a market-cap weighted index must be adjusted for stock splits but not for dividends.

B) the use of price weighting versus market value weighting produces a downward bias on the index.

C) buying 100 shares of each stock in a price-weighted index will result in a portfolio that tracks the index quite well.

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A price-weighted index needs to be adjusted for stock splits, but a market-cap weighted index does not. Neither type of index considers dividend income unless it is designed as a total return index.
Price weighting produces a downward bias compared to market weighting because firms that split their stocks (which tend to be the more successful firms) decrease in weight within a price-weighted index. The returns on a price-weighted index can be matched by purchasing a portfolio with an equal number of shares of each stock in the index.

Gypsy

An index was recently begun with the following two stocks:

• Company A – 50 shares valued at $2 each.
• Company B – 10 shares valued at $10 each.

Given that the value-weighted index was originally set at 100 and Company A's stock is currently selling for $4 per share while Company B’s stock is still at $10 per share, what is the current value of the price-weighted index and the market-cap-weighted index?

Price-weighted

Market-cap-weighted

A) 7 150

B) 8 150

C) 7 300

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Price weight = [(4) + (10)] / 2 = 7
Market-cap weight = [(4)(50) + (10)(10)] / [(2)(50) + (10)(10)](100) = 150

Gypsy

Reconstitution of an index refers to:

A) removing some securities from the index and adding others.

B) adjusting the weights of the securities that constitute the index.

C) changing the methodology used to calculate the value of the index.

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Reconstitution begins with evaluating the securities in an index against the index’s criteria. Securities that are no longer representative of the index are removed and replaced with different securities that do meet the criteria. Adjusting the weights of the securities that constitute an index is termed rebalancing.

Gypsy

The providers of the Smith 30 Stock Index remove Jones Company from the index because it has been acquired by another firm, and replace it with Johnson Company. This change in the index is best described as an example of:

A) rebalancing.

B) redefinition.

C) reconstitution.

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Reconstitution refers to changing the securities that make up an index. Reconstitution of an index is required if one of its constituent securities goes out of existence (for example, a maturing bond or an expiring futures contract) or no longer meets the requirements to be included in the index.

Gypsy

When a security is added to a widely followed market index, the security’s price is most likely to:

A) increase.

B) decrease.

C) be unaffected.

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Adding a security to a market index typically causes an increase in that security’s price as portfolio managers who track the index purchase the security.

Gypsy

The most appropriate benchmark for measuring the relative performance of an investment manager is:

A) a broad market index.

B) an index that closely matches the manager’s investment approach.

C) the risk-adjusted return on the market portfolio.

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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.