Security Market Indices: Chapter Test

Security Market Indices: Chapter Test (10 Questions, 15 minutes)

(1) Calculate the total return of a price-weighted index constituting three securities. The details of the securities are given in the table below:

(a) - 3.11 percent
(b) - 1.17 percent
(c) 6.74 percent

(2) Which of the following statements is most accurate about the equal-weighted index?

(a) The higher priced security will have more impact on the return calculation
(b) The security with higher market capitalization will have more impact on the return calculation
(c) All securities will have the same impact on the return calculation

(3) Which of the following weighted indices is most likely to have a value tilt?

(a) Fundamentally weighted index
(b) Equal-weighted index
(c) Price-weighted index

(4) Which of the following indices is most likely to be rebalanced regularly?

(a) Price-weighted index
(b) Market capitalization weighted index
(c) Fundamentally weighted index

(5) Which of the following indices is least likely to have the momentum effect in assigning the weight of the securities over the periods?

(a) Price-weighted index
(b) Fundamentally weighted index
(c) Market capitalization weighted index

(6) Which of the following statements is most accurate about the reconstitution?

(a) It leads to less portfolio turnover
(b) It reduces the likelihood that the index includes securities that are not representative of the target market
(c) It always leads to a decrease in the weight of the constituent securities of the index

(7) Calculate the price return of a market capitalization weighted index consisting of three securities. The details of the securities are given in the table below:

(a) 14.23 percent
(b) 29.22 percent
(c) 33.66 percent

(8) Which of the following statements is least accurate about the REIT indices?

(a) REIT indices are based on publically traded REITs
(b) REIT indices are valued on a continuous basis
(c) REIT indices are valued on a periodic basis

(9) Which of the following statements is most accurate about the hedge fund indices?

(a) The hedge fund indices are more likely to report the performance of hedge funds that are performing well
(b) The hedge fund indices are more likely to report the performance of hedge funds that are performing poorly
(c) The providers of hedge fund indices determine the constituent of the indices

(10) What is the common distinction between the investment grade indices and high-yield indices for the fixed income securities?

(a) The high-yield indices are typically further subdivided by maturity and credit rating
(b) The investment grade indices are typically further subdivided by maturity and credit rating
(c) The high-yield indices are subdivided by credit rating and the investment grade indices are subdivided by maturity




Solutions to the Chapter Test

(1) Correct Answer is B: The total return of the price-weighted index = (Sum of final prices including dividends/Sum of initial prices) - 1 = [(42+1+32+0+175+4)/(40+27+190)] - 1 = 254/257 -1 = -1.17 percent.

(2) Correct Answer is C: All securities have the same impact on the return calculation for the equal-weighted index because the weights of all the constituent securities are equal.

(3) Correct Answer is A: The fundamentally weighted indices have the value tilt.

(4) Correct Answer is C: The price-weighted index and market capitalization-weighted index are not rebalanced as their weights get rebalanced automatically with the change in the price of the securities. However, the fundamentally weighted index allocates the weights depending on the fundamental factors rather than price and hence these indices need to be rebalanced periodically.

(5) Correct Answer is B: The momentum effect is most prominent in the market capitalization weighted index. The momentum effect is the effect because of which the weight of the security increases on the increase in the price of the security and decreases with a decrease in the price of the security. A price-weighted index can also have the momentum effect. However, the fundamentally weighted index usually have the value tilt and has a contrarian effect rather than momentum effect.

(6) Correct Answer is B: The reconstitution leads to higher turnover as the weights are needed to be adjusted. The weight of the constituent securities can increase or decrease on reconstitution. Reconstitution reduces the likelihood that the index includes securities that are not representative of the target market.

(7) Correct Answer is A: Total market capitalization of the index at the beginning of the period = 12.5*450,000 + 40*200,000 + 8.25*500,000 = $17,750,000. Total market capitalization of the index at the end of the period = 10.5*550,000 + 50*200,000 + 18*250,000 = $20,275,000. Price return of the index = (20,275,000/17,750,000) - 1 = 14.23 percent.

(8) Correct Answer is C: REIT indices are based on publicly traded REITs with continuous market pricing. Therefore, the value of REIT indices is also calculated continuously.

(9) Correct Answer is A: The hedge fund indices are more likely to report the performance of hedge funds that are performing well because they report their performance voluntary and the only the well-performing hedge funds are more likely to report the performance. The constituents of the index determine the index rather than the index providers.

(10) Correct Answer is B: The investment grade securities are typically further subdivided by maturity and credit rating.