Gypsy

The Top Banking Index contains stocks in the finance industry that represent more than 90% of the total market capitalization for the finance industry. The index is best described as a:

A) broad market index.

B) sector index.

C) style index.

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A sector index measures the returns for an industry sector such as financials. Style indexes measure the returns to strategies that are differentiated by market capitalization and by value or growth. A broad market index typically consists of constituent securities that represent 90% or more of the total market capitalization for a given market.

Gypsy

Which type of security market index provides a measure of a market’s overall performance and usually contains a significant portion of the market’s total value?

A) Broad market indexes.

B) Sector indexes.

C) Style indexes.

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A broad market index typically consists of securities that represent 90% or more of the total market capitalization for a given market. The object of a broad market index is to provide a measure for the performance of the total market. A sector index measures the returns for an industry sector such as financials. Style indexes measure the returns to strategies that are differentiated by market capitalization and by value or growth.

Gypsy

An equity index comprised of value stocks, identified by their price-to-earnings ratios, is best described as a:

A) style index.

B) sector index.

C) fundamental weighted index.

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An index of value stocks is an example of a style index. Sector indexes measure the performance of securities in specific industries or industry sectors. Fundamental weighting is used to weight indexes by a factor such as the size of the firms or economies represented in the index.

Gypsy

Contreras Fund is a mutual fund that invests in value stocks. The most appropriate type of equity index to use as a benchmark of manager performance for Contreras Fund is a:

A) sector index.

B) style index.

C) broad market index.

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The index selected as a benchmark for manager performance should represent the investment universe from which the manager actually selects stocks. If the manager only invests in value stocks, then the most appropriate index is a style index that seeks to represent the returns from a value strategy. A sector index is appropriate for managers who invest in specific sectors (e.g., technology stocks, emerging market bonds).

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.

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 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

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

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

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.