B** Calculate and interpret the value, price return, and total return of an index. Flashcards Preview

L1 47 Security Market Indices > B** Calculate and interpret the value, price return, and total return of an index. > Flashcards

Flashcards in B** Calculate and interpret the value, price return, and total return of an index. Deck (9)
Loading flashcards...
1
Q

A Price Index: The price return to an index is the
percentage change in the value of the
index over a given interval.

A

A price index uses only the prices of the constituent securities in the return calculation. The rate of return is called a price return.

A price index only includes the prices of the constituent securities in the calculation of the index value

2
Q
A Total Return Index: The total return of an index is the index
price return plus any income (dividend
or interest) yield associated with
holding the underlying securities (less
any carrying costs, if applicable).
A
A total return index reflects both price
appreciation and the reinvestment of all
income.
• Returns to a total return index will
exceed those to a price index.
• If they both start with the same initial
value, over time, the total return index
will exceed the price index.

A total return index uses both the price of and the income from the index securities in the return calculation.

the total return index at the end of the year will be: equal to the price index if the constituent stocks do not pay dividends.

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.

The total return on a security market index includes cash flows from the securities (dividends and interest) as well as price changes.

The value of a total return index: can be calculated by multiplying the beginning value by the geometrically linked series of periodic total returns.

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.

3
Q

Index Return Formula (A - B / B)

A

Return = Index Value - Prev. Index Value / Prev. Index Value

4
Q

Total Return Index Formula

A

A - B + Inctotal index / B

5
Q

Index Values over T

A

V t+1 = Vt(1+r)=Vt-2(1+rt-2)(1+rt-1)(1+rt)

6
Q

Index Calculation Issues

A

• Averaging method
• Dealing with splits, large distributions,
and reconstitution (additions and
deletions from the list).

7
Q

the choices and issues in index construction and management.: Decisions that index providers must make when constructing and managing indexes include: SchweserNotes: Book 4 p.229
CFA Program Curriculum: Vol.5 p.84

A

The target market the index will measure.
Which securities from the target market to include.
The appropriate weighting method.
How frequently to rebalance the index to its target weights.
How frequently to re-examine the selection and weighting of securities.

The first decision that must be made is choosing the target market the index will represent (The target market for a security market index is best described as the: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.). 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

8
Q

the different weighting methods used in index construction. SchweserNotes: Book 4 p.229
CFA Program Curriculum: Vol.5 p.85

A

A price-weighted index is the arithmetic mean of the prices of the index securities. The divisor, which is initially equal to the number of securities in the index, must be adjusted for stock splits and changes in the composition of the index over time. Which of the following statements best describes the investment assumption used to calculate an equal weighted price indicator series? An equal dollar investment is made in each stock in the index. 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? 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.

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.

An equal-weighted index assigns the same weight to each of its constituent securities.

A market capitalization-weighted index gives each constituent security a weight equal to its proportion of the total market value of all securities in the index. Market capitalization can be adjusted for a security’s market float or free float to reflect the fact that not all outstanding shares are available for purchase. In a market-capitalization weighted index firms with: greater market caps have greater 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.

A fundamental-weighted index uses weights that are independent of security prices, such as company earnings, revenue, assets, or cash flow.

9
Q

Index Return Q’s

A

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