Question

It turns out empirically that when a stock that was previously not included in the S&P500 Index is included, and one that was in the index is excluded, there are price impacts to both stocks.

a. If the announcement of the change in the composition of the index was made 2 weeks prior to the change, what would you expect to happen in the two weeks leading up to the change? Why?

b. What would you expect to happen to the prices of the stocks on the day of the change? Why?

Answer 1

A. If it is announced two weeks earlier before the change in the composition of index, people will start to discount the effect of decision leading to the day of change.

The stock which will be excluded out of the index will start to lose it's value and the share which will be included in the index will start to gain upward traction in it's share price.

This is because the index funds will infuse the money into the share which will be included in the index and Index funds will plough out the money of the stock which is being excluded from the index.

B. I expect to see the prices of stocks showing high level of volatility on the day of the change.

The stock which is being excluded from the index will turn bearish as people will try to get out if stock as it's a short term negative.

The stock which is being included in the index will start to show bullish momentum as Index funds will start to invest into the stock which will fuel the share price in the upside.