market indexes

Question 1

What is a security market index?

Answer 1

A security market index is used to represent the performance of an asset class, security market, or segment of a market.

Question 2

What are constituent securities?

Answer 2

Constituent securities are individual securities that make up a security market index.

Question 3

How is an index value calculated?

Answer 3

An index value is calculated from the market prices of its constituent securities at a point in time.

Question 4

What is an index return?

Answer 4

An index return is the percentage change in the index’s value over a period of time.

Question 5

What is the difference between a price index and a return index?

Answer 5

A price index uses only the prices of the constituent securities, while a return index includes both prices and income from the securities.

Question 6

What is a price return?

Answer 6

A price return is a rate of return calculated based on a price index.

Question 7

What is a total return?

Answer 7

A total return is a rate of return calculated based on a return index, including interim cash flows such as dividends or interest payments.

Question 8

How is the portfolio return calculated?

Answer 8

RP = (1 + RS1)(1 + RS2)(1 + RS3)…(1 + RSk) − 1

Question 9

What does k represent in the portfolio return formula?

Answer 9

k represents the total number of subperiods.

Question 10

What is the formula to calculate the portfolio return?

Answer 10

RP = (1 + RS1)(1 + RS2) − 1

Question 11

What must index providers decide when constructing an index?

Answer 11

• Target market to measure
• Securities to include
• Weighting method
• Rebalancing frequency
• Timing for re-examining securities

Question 12

What is a price-weighted index?

Answer 12

A price-weighted index is an arithmetic average of the prices of the securities included in the index.

Question 13

What is a disadvantage of a price-weighted index?

Answer 13

A higher priced stock has a greater impact on the index’s value than a lower priced stock.

Question 14

What are two major examples of price-weighted indexes?

Answer 14

• Dow Jones Industrial Average (DJIA)
• Nikkei Dow Jones Stock Average

Question 15

How is an equal-weighted index calculated?

Answer 15

An equal-weighted index is calculated as the arithmetic average return of the index stocks.

Question 16

What is a disadvantage of an equal-weighted index?

Answer 16

It requires periodic rebalancing, leading to high transaction costs.

Question 17

What is a market capitalization-weighted index?

Answer 17

A market capitalization-weighted index has weights based on the market capitalization of each index stock.

Question 18

What does market float represent?

Answer 18

Market float is the total value of the shares actually available to the investing public.

Question 19

What is a float-adjusted market capitalization-weighted index?

Answer 19

A float-adjusted market capitalization-weighted index is based on the proportionate value of each firm’s shares available to investors.

Question 20

What is fundamental weighting in an index?

Answer 20

Fundamental weighting uses weights based on firm fundamentals, such as earnings or cash flow.

Question 21

What is an advantage of a fundamental-weighted index?

Answer 21

It avoids the bias of market capitalization-weighted indexes toward overvalued firms.

Question 22

How is a price-weighted index calculated?

Answer 22

It adds the market prices of each stock and divides by the number of stocks, adjusted for splits.

Question 23

What happens to a price-weighted index when a stock splits?

Answer 23

The divisor is adjusted to maintain the index value.

Question 24

How is a market capitalization-weighted index calculated?

Answer 24

It sums the total value of all stocks and divides by a similar sum during the base period.

Question 25

What is the formula for calculating the current index value in a market capitalization-weighted index?

Answer 25

current index value = (current total market value of index stocks / base year total market value of index stocks) × base year index value

Question 26

What is the impact of a high-priced stock on a price-weighted index?

Answer 26

A high-priced stock disproportionately influences the index value.

Question 27

What does an equal-weighted index imply about the effect of price changes?

Answer 27

A dollar change in price has the same effect regardless of the stock's price.

Question 28

What is a market capitalization-weighted index?

Answer 28

An index where returns on stocks are influenced by their market capitalizations.

Question 29

How does an equal-weighted index differ from a market capitalization-weighted index?

Answer 29

It places equal weight on the returns of all index stocks, regardless of their prices or market values.

Question 30

What is the formula for calculating the change in an equal-weighted index?

Answer 30

Change in index = (Return of Stock A + Return of Stock B + Return of Stock C) / Number of Stocks

Question 31

Calculate the new index value if the initial index value is 131 and the change is 11.9%. What is the new index value?

Answer 31

146.59

Question 32

What is rebalancing in the context of an index?

Answer 32

Adjusting the weights of securities in a portfolio to their target weights after price changes.

Question 33

What does index reconstitution refer to?

Answer 33

Periodically adding and deleting securities that make up an index.

Question 34

True or False: When a security is added to an index, its price tends to fall.

Answer 34

False

Question 35

List three uses of security market indexes.

Answer 35

* Reflection of market sentiment * Benchmark of manager performance * Measure of market return and risk

Question 36

What is a broad market index?

Answer 36

An index that provides a measure of a market's overall performance, typically containing more than 90% of the market's total value.

Question 37

What is a multi-market index?

Answer 37

An index constructed from the indexes of markets in several countries to measure equity returns of a geographic region.

Question 38

Define a sector index.

Answer 38

An index that measures the returns for an industry sector such as health care or financial firms.

Question 39

What is a style index?

Answer 39

An index that measures returns to market capitalization and value or growth strategies.

Question 40

What are some characteristics of fixed-income indexes?

Answer 40

* Created for various sectors and regions * High turnover due to bond maturity * Dependence on dealer markets for pricing

Question 41

What is an alternative investment index?

Answer 41

An index that represents alternative assets such as commodities, real estate, and hedge funds.

Question 42

What are commodity indexes based on?

Answer 42

Futures contracts on commodities such as grains, livestock, metals, and energy.

Question 43

What is a key issue with commodity indexes?

Answer 43

The weighting method can significantly affect exposure and risk-return characteristics.

Question 44

What is a REIT?

Answer 44

A Real Estate Investment Trust that invests in properties or mortgages and issues ownership interests to investors.

Question 45

How do hedge fund indexes typically weight returns?

Answer 45

Most hedge fund indexes equally weight the returns of the hedge funds included.

Question 46

What is a potential bias in hedge fund index returns?

Answer 46

An upward bias due to poorly performing funds often not reporting their performance.