Question

1) You own the following portfolio and wish to make an index of your portfolio performance. Use an initial index of 100 where appropriate.

Stock		t = 1	t = 2
A	500 shares	$58 per share	$63 per share
B	600 shares	$44 per share	$49 per share
C	200 shares	$61 per share	$55 per share

a) What is the value of the price weighted index at t = 1 and t = 2?

b) Assuming that t = 1 is the base year (Index = 100), what is the value weighted price at t = 2?

c) Briefly explain the advantages and disadvantages of each type of index.

Answer 1

c) The major advantage of price weighted index is it is simple to calculate and can be easily explained to anyone. The disadvantage associated with the use of price weighted index is that it overweight’s the large price stock and underweight the small price stocks. In the when there is stock split the index divisor has to be adjusted.

The advantage of value weighted index is that it focuses on the total market cap of the company and not just the stock price. The value weighted index consists of large number of stocks in the portfolio so there is enough diversification. The major disadvantage of this index is that it is very much correlated with the economy and if the economy is not doing well your portfolio will might not do well.