Chapter 2: Security Market Indices

Chapter 2: Security Market Indices

1 Which of the following statements is true regarding the
calculation of an index return?

A. A price return considers both the prices and income

generated by the constituent securities.
B. A return index only takes into account the prices of the
constituent securities.
C. A total return includes both the prices and income generated
by the constituent securities.
2 Suppose we have an index that experienced returns of 1.8% in
the first period, 2.5% in the second period, and 1.2% in the third
period. If the starting index value is 2831, its value after the three
periods?

A. 2907
B. 2956
C. 2989
3 What are some decisions that index providers must make when
constructing an index?

A) Which securities to include and how to weight them

B) What the target market is and how often to rebalance the
index
C) How to market the index to investors

4 What is tracking error?

A) The difference in performance between the index and its

benchmark
B) The amount of time it takes to rebalance an index
C) The fees charged by index providers to license the index to
third-party providers

5 What is a concern with an equal-weighted index?

A) Its weights on the returns of large capitalization firms in the
index are greater than their proportions of the overall market
value of the index stocks.
B) It is difficult to calculate and rebalance
C) The weights placed on the returns of smaller capitalization
firms are greater than their proportions of the overall market
value of the index stocks.
6 What is the primary advantage of a market capitalization-
weighted index?
A) The relative impact of a stock's return on the index decreases
as its price falls
B) Index security weights represent proportions of total market
value
C) It avoids the bias of market capitalization-weighted indexes
toward the performance of overvalued firms.
7 What is a primary advantage of a fundamental-weighted index?
1
Chapter 2: Security Market Indices

A) Its weights are based on the market capitalization of each

index stock
B) It avoids the bias of market capitalization-weighted indexes
toward the performance of overvalued firms
C) A given percentage change in the price of a higher priced
stock has a greater impact on the index's value than does an
equal percentage change in the price of a lower priced stock.
8 What is the percentage change in the price-weighted index from
Month 1 to Month 2, given the following data?

Stock Month 1 Month 2

X $15 $25
Y $25 $20
Z $40 $30

A. -6.11%
B. -6.26%
C. -6.33%
9 At the market close on day 1, Stock A has a price of $10, Stock B
has a price of $20, and Stock C has a price of $90. The value of a
price-weighted index of these three stocks is (10 + 20 + 90) / 3 =
40 at the close of trading. If Stock C splits 2-for-1, effective on day
2, what is the new denominator for the index?

A) 3.33
B) 1.875
C) 2.5

10 Use this Table:

As of January 1st As of December 31st

Share Share Share Share
Stock
Price Outstanding Price Outstanding
A $22 1,500 $28 1,500
B $40 10,000 $50 10,000
C $34 3,000 $30 3,000

The 1-year return on a price-weighted index of these three

stocks is closest to:

A. 12.5%.
B. 13.5%.
C. 18.0%.
11 Use this Table:

As of January 1st As of December 31st

Share Share Share Share
Stock
Price Outstanding Price Outstanding
A $22 1,500 $28 1,500
B $40 10,000 $50 10,000
C $34 3,000 $30 3,000

2
Chapter 2: Security Market Indices

The 1-year return on an equal-weighted index of these three

stocks is closest to:

A. 12.0%.
B. 12.5%.
C. 13.5%.
12 Use this Table:

As of January 1st As of December 31st

Share Share Share Share
Stock
Price Outstanding Price Outstanding
A $22 1,500 $28 1,500
B $40 10,000 $50 10,000
C $34 3,000 $30 3,000

The 1-year return on a market capitalization-weighted index of

these stocks is closest to:

A. 12.5%.
B. 13.5%.
C. 18.0%.
13 Choices that must be made when constructing a security market
index least likely include whether to:

A. use a nominal or interval scale.

B. measure the performance of an entire market or market
segment.
C. weight the securities equally or by some firm-specific
characteristic.

14 Market float of a stock is best described as its:

A. total outstanding shares.

B. shares that are available to domestic investors.
C. outstanding shares, excluding those held by controlling
shareholders.
15 For which of the following indexes will rebalancing occur most
frequently?

A. A price-weighted index.
B. An equal-weighted index.
C. A market capitalization-weighted index.
16 What is the purpose of rebalancing an index portfolio?

A. To add and remove securities from the index

B. To maintain target weights of securities in the portfolio after
price changes
C. To adjust the index returns to match the portfolio returns
17 What is the purpose of index reconstitution?
A. To adjust the weights of securities in an index
B. To add and remove securities from the index
C. To calculate the returns of an index portfolio

3
Chapter 2: Security Market Indices

18 What is the use of an index in the capital asset pricing model

(CAPM)?

A. To estimate a stock’s risk-adjusted return

B. To reflect market sentiment
C. To measure market return and risk
19 What is the purpose of index funds?

A. To reflect market sentiment

B. To provide a model portfolio for passive investing
C. To measure market return and risk
20 What is the difference between a broad market index and a
multi-market index?

A. A broad market index contains more than 90% of a market's

total value, while a multi-market index comprises market indexes
from several countries
B. A broad market index measures the returns for an industry
sector, while a multi-market index measures the equity returns of
a geographic region
C. A broad market index uses market capitalization-weighting,
while a multi-market index uses fundamental weighting
21 What is the primary challenge in constructing fixed-income
indexes?

A) High transaction costs

B) Illiquidity of securities
C) Limited availability of securities
22 What is the primary reason for the high turnover in fixed-income
indexes?

A) The large number of fixed-income securities

B) The infrequent trading of fixed-income securities
C) The maturity of fixed-income securities
23 Which of the following statements is true about municipal bond
indexes?

A) They only include bonds issued by the US government

B) They only include bonds issued by corporations
C) They only include bonds issued by state and local
governments
24 How are commodity indexes constructed?
a) Based on the spot prices of commodities
b) Based on the prices of commodity futures contracts
c) Based on the production values of commodities
25 What is the potential bias in hedge fund index returns?
a) An upward bias due to the inclusion of poorly performing
funds
b) A downward bias due to the exclusion of poorly performing
funds
c) No bias, as all hedge funds report their performance to index
providers
4
Chapter 2: Security Market Indices

26 The publisher of an index that includes 50 corporate bonds

removes from the index three bonds that are nearing maturity
and one whose issuer has defaulted and selects four actively
traded bonds to replace them in the index. This bond index is
said to have been:

A. redefined.
B. rebalanced.
C. reconstituted.
27 Which of the following would most likely represent an
inappropriate use of an index?

A. As a reflection of market sentiment.

B. Comparing a small-cap manager against a broad market.
C. Using the CAPM to determine the expected return and beta.
28 An index of 200 mid-cap growth stocks is best described as:

A. a style index.
B. a sector index.
C. a broad market index.
29 Which of the following is least accurate regarding fixed-income
indexes?

A. Replicating the return on a fixed-income security index is

difficult for investors.
B. There is a great deal of heterogeneity in the composition of
fixed-income security indexes.
C. Due to the large universe of fixed-income security issues,
data for fixed-income securities are relatively easy to obtain.
30 Which of the following indexes of alternative investments is most
likely to be calculated from derivatives prices?

A. Real estate index.

B. Commodity index.
C. Hedge fund index.
31 Most of the widely used global security indexes are:

A. price weighted.
B. equal weighted.
C. market capitalization weighted.
32 A security market index represents the:

A risk of a security market.

B security market as a whole.
C security market, market segment, or asset class.
33 Security market indexes are:

A. constructed and managed like a portfolio of securities.

B. simple interchangeable tools for measuring the returns of
different asset classes.
C. valued on a regular basis using the actual market prices of
the constituent securities.
5
Chapter 2: Security Market Indices

34 When creating a security market index, an index provider must

first determine the:
A target market.
B appropriate weighting method.
C number of constituent securities.
35 One month after inception, the price return version and total
return version of a single index (consisting of identical securities
and weights) will be equal if:

A market prices have not changed.

B capital gains are offset by capital losses.
C the securities do not pay dividends or interest.
36 The values of a price return index and a total return index
consisting of identical equal-weighted dividend-paying equities
will be equal:

A only at inception.
B at inception and on rebalancing dates.
C at inception and on reconstitution dates.
37 When creating a security market index, the target market:

A determines the investment universe.

B is usually a broadly defined asset class.
C determines the number of securities to be included in
the index.
38 Which of the following index weighting methods requires an
adjustment to the divisor after a stock split?

A Price weighting.
B Fundamental weighting.
C Market-capitalization weighting.
39 If the price return of an equal-weighted index exceeds that of a
market- capitalization-weighted index comprised of the same
securities, the most likely explanation is:

A stock splits.
B dividend distributions.
C outperformance of small-market-capitalization stocks.
40 A float-adjusted market-capitalization-weighted index weights
each of its con- stituent securities by its price and:

A its trading volume.

B the number of its shares outstanding.
C the number of its shares available to the investing
public.
41 Which of the following index weighting methods is most likely
subject to a value tilt?

A Equal weighting.
B Fundamental weighting.
C Market-capitalization weighting.

6
Chapter 2: Security Market Indices

42 Rebalancing an index is the process of periodically adjusting the

constituent:

A securities’ weights to optimize investment performance.

B securities to maintain consistency with the target
market.
C securities’ weights to maintain consistency with the
index’s weighting method.
43 Which of the following index weighting methods requires the
most frequent rebalancing?

A Price weighting.
B Equal weighting.
C Market-capitalization weighting.
44 Reconstitution of a security market index reduces:

A portfolio turnover.
B the need for rebalancing.
C the likelihood that the index includes securities that are
not representative of the target market.
45 Security market indexes are used as:

A measures of investment returns.

B proxies to measure unsystematic risk.
C proxies for specific asset classes in asset allocation
models.
46 Uses of market indexes do not include serving as a:

A measure of systemic risk.

B basis for new investment products.
C benchmark for evaluating portfolio performance.
47 Which of the following statements regarding sector indexes is
most accurate? Sector indexes:

A track different economic sectors and cannot be

aggregated to represent the equivalent of a broad market index.
B provide a means to determine whether an active
investment manager is more successful at stock selection or
sector allocation.
C apply a universally agreed upon sector classification
system to identify the constituent securities of specific economic
sectors, such as consumer goods, energy, finance, health care.
48 Which of the following is an example of a style index? An index
based on:

A geography.
B economic sector.
C market capitalization.

49 Which of the following statements regarding fixed-income

indexes is most accurate?

7
Chapter 2: Security Market Indices

A Liquidity issues make it difficult for investors to easily

replicate fixed- income indexes.
B Rebalancing and reconstitution are the only sources of
turnover in fixed- income indexes.
C Fixed-income indexes representing the same target
market hold similar numbers of bonds.
50 An aggregate fixed-income index:

A comprises corporate and asset-backed securities.

B represents the market of government-issued securities.
C can be subdivided by market or economic sector to
create more narrowly defined indexes.
51 Fixed-income indexes are least likely constructed on the basis
of:
A maturity.
B type of issuer.
C coupon frequency.
52 Commodity index values are based on:
A futures contract prices.
B the market price of the specific commodity.
C the average market price of a basket of similar
commodities.
53 Which of the following statements is most accurate?
A Commodity indexes all share similar weighting
methods.
B Commodity indexes containing the same underlying
commodities offer similar returns.
C The performance of commodity indexes can be quite
different from that of the underlying commodities.

54 Which of the following is not a real estate index category?

A Appraisal index.
B Initial sales index.
C Repeat sales index.

55 A unique feature of hedge fund indexes is that they:

A are frequently equal weighted.
B are determined by the constituents of the index.
C reflect the value of private rather than public
investments.
56 The returns of hedge fund indexes are most likely:
A biased upward.
B biased downward.
C similar across different index providers
57 In comparison to equity indexes, the constituent securities of
fixed-income indexes are:
A more liquid.
B easier to price.
C drawn from a larger investment universe.