Question

2. Describe the construction of stock market indexes.

3. How would you calculate the profit or loss on investments in options and future contracts?

Answer 1

Q - 2

• Stock market indexes are supposed to be the reflection of the state of economy. A stock market index is constructed by theoretically including a number of stocks in the base and calculating it's value based on the weights of the individual stocks.
• An index is just a pure number, it doesn't have any units.
• Most of the time the index starts with an assigned value of 100 or 1,000.
• Stocks in the index can move in and out of the index.
• The weightage assigned to a stock in the index can be based on the market capitalization of the stock.
• Index numbers are assigned a base date.
• It's the change in index value that gives us an indication of the performance of the capital markets, to the investors.

Q - 3

In case of options, depending upon whether it's a call option or a put option, the net profit or loss is calculated as = Paoff from the option - initial investment.

Let's assume S is the stock price at the time of expiration of the option and K be the strike price.

Hence, in case of a call option, the net profit / loss can be calculated as = max (S - K, 0) - C where C is the call premium paid to buy the call option.

Hence, in case of a put option, the net profit / loss can be calculated as = max (K - S, 0) - P where P is the put premium paid to buy the put option.

Net profit / (loss) in case of future contracts = S - K

There is no initial investment in buying or selling the future contract.