37. Security Market Indexes

Question 1

A security market index

Answer 1

represents a market segment or asset class. The individual securities that make up the index are called constituent securities.

Question 2

An equity index

Answer 2

is a portfolio that is designed to represent the performance of an asset class (e.g., US equities). Upon creation, an index selects a divisor that produces a convenient initial level, such as 1,000. Over time, the divisor is adjusted so that the index’s performance remains consistent with historical returns despite changes to its constituents and weights

Question 3

Price weighting

Answer 3

weights each constituent security based on its price as a share of the sum of all the constituent security prices. The Dow Jones Industrial Average (DJIA) is one of the oldest and best-known price-weighted indexes.

Question 4

Equal weighting

Answer 4

is an index weighing technique that offers the advantage of simplicity. Each stock in an equally weighted index has the same proportionate impact on the index’s overall performance. It is like investing an equal amount of money in each component stock.

Question 5

Market-Capitalization Weighting

Answer 5

Under market-capitalization weighting (a.k.a. value-weighting), the weight of each security is its market capitalization divided by the total market capitalization of all constituent securities. A company’s market capitalization is the number of shares outstanding times the price per share.

Question 6

float adjustment

Answer 6

excludes the impact of shares that are not freely exchanged

Question 7

Fundamental weighting

Answer 7

uses a measure of company size not dependent upon security price to determine weight.

Question 8

Reconstitution

Answer 8

process in which the manager reviews and makes changes to the constituent securities. Some indices reconstitute annually. Events such as bankruptcies, mergers, acquisitions, and de-listings may prompt index providers to replace an acquired firm with another representative firm