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.

---

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

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.

---

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 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.

---

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

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.

---

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

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.

Gypsy

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.

Gypsy

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.

Gypsy

The value of a security market index at the end of December is 1,200. The index returns for the next six months are:

Month	Return
January	3.89%
February	8.76%
March	−4.74%
April	6.88%
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.

Gypsy

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.

Gypsy

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.