EQUITY MODULE 40

Question 1

40.1 What are security market indexes?

+ what is the difference between price return and total return?

Answer 1

price return = tracking the share price purely of securities within the index

total return = takes cash flows from dividends etc or interest - so the overall value of the investment

Question 2

40.1 Describe some index construction decisions:

Answer 2

Question 3

40.1 describe an overview of different weighting schemes that can be found within indexes:
- price weighted
- equal weighted
- market cap weighted
- fundamental

Answer 3

dow jones - does the price weighted index

market cap weighted - could be calculated by shares x price, but sometimes is calculated including free float too

Question 4

40.1 Describe the process of working out the price return of a price-weighted index:

+ what if one of the stock do a stock split?

Answer 4

in a stock split, we have to change the divisor value - and to do this we have to reshuffle the equation

CFA questions - it might just be that knowing that the divisor goes down, gets you the right answer

Question 5

40.1 Describe the process of working out the total return of an equal-weighted index:

Answer 5

Question 6

40.1 Describe the process of working out the price return of a market-cap-weighted index:

Answer 6

multiply across shares outstanding x BOP price to get market cap.

do this for BOP and EOP.

if this was total return - we would add the dividend to the EOP price to get the market cap on a total return basis

Question 7

40.1 Describe the process of working out the price return of a market-cap-weighted index:

BUT - this time adjust for free float.

Answer 7

once again calculate BOP and EOP market cap and adjust them for free float percentage

Question 8

40.1 Describe the fundamental weighted indices:

Answer 8

Question 9

40.1 Describe the process of rebalancing an index:

Answer 9

Question 10

40.1 Describe the process of reconstitution in an index:

Answer 10

can get some distortion around stocks just on the edge of an index

Question 11

40.1 What are the uses of security market indexes?

Answer 11

Question 12

40.1 What are the different types of equity indexes?

Answer 12

Question 13

40.1 Describe some non-equity indexes:

Answer 13

Question 14

40.1 Why does police weighting produce a downward bias?

Answer 14

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.

Question 15

40.1 the returns on a price-weighted index can be matched by…

Answer 15

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.

Question 16

40.1 What is an example of a price weighted index?

Answer 16

The Nikkei Dow Index.

Question 17

40.1 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:

Answer 17

Style index

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.

Question 18

40.1 Commodity price indexes are based on the prices of:

Answer 18

Futures contracts

The constituent securities of commodity price indexes are commodity futures contracts. As a result, the return on a commodity index can be different than the returns from holding the constituent commodities themselves.

Question 19

40.1 For which type of index will rebalancing happen most frequently?

Answer 19

equal weighted

An equal-weighted index will be rebalanced most frequently because as stock prices change, their representation in the index needs to be adjusted. Price-weighted and market capitalization-weighted indexes do not usually need rebalancing.

Question 20

40.1 An index of 200 mid-cap growth stocks is best described as a:

Answer 20

style index