Question

11. A benchmark market value index is comprised of three stocks. Yesterday the three stocks were priced at $18, $28, and $60. The number of outstanding shares for each is 760,000 shares, 660,000 shares, and 360,000 shares, respectively. If the stock prices changed to $22, $26, and $62 today respectively, what is the 1-day rate of return on the index?

a. ​3.20%

b. ​7.17%

c. ​5.35%

d. ​4.54%

12. Which of the following does not approximate the performance of a buy-and-hold portfolio strategy?

a. An equally weighted index

b. All of these options (Weights are not a factor in this situation.)

c. A value-weighted index

d. A price-weighted index

13. What distinguishes a pure discount bond from a regular bond?

a. A discount bond pays coupons and regular bond does not

b. A discount bond is sold a premium to par value and a regular bond is not

c. A regular bond pays coupons and a discount bond does not

d. None of the above

Answer 1

1) Option D is correct Choice, let us understand further,

Consider stocks as Stock A, Stock B, Stock C

Formual to calculate the Market Value of the Index is summation of product of price and shares outstanding,

Market Value of Index = Summation of ( Share Price * Share Outstanding)

At Start	Price at Start	Share Outstanding	Market Value
Stock A	$18	760000	13680000
Stock B	$28	660000	18480000
Stock C	$60	360000	21600000
Index Value			53760000

Index Value at end of the period i.e on next day,

At End	Price at Start	Share Outstanding	Value
Stock A	$22	760000	16720000
Stock B	$26	660000	17160000
Stock C	$62	360000	22320000
Index Value			56200000

Return = (End Value / Start Value) -1 * 100

Return = (56200000/53760000) -1 *100

Return = 4.54%

2) Option c is the correct choice.

let us understand given index in detail,

a) Equally Weighted Index = In Equally weighted index, equal weight is given to all the stocks available in the index, which means if investor invest in such index then his or her AUM is allocated to all the stocks at equal weights.

The disadvantage of this index is, investor has to churn the stock as per the performance of the stock. If any one stock has perform well then that stock should be sold after price gain hence turnover is high in such strategy which doesnt go with buy and hold strategy.

c) Value Weighted Index = In Value Weighted Index, weight is assign to the stock based on it's market value which is nothing but the product of no of shares outstanding and share price. The higher the market value, better is the weightage assign to stock hence more funds are allocated when investor invest in such index.  

Higher market value defines the strong fundamentals of the stock hence allocating higher weight and higher funds as per weightage is good for buy and hold strategy.

d) Price Weighted Index = In Price Weighted Index, weight is assign in the index as per the price of the stock. The stock which has higher price will benefit with the higher weight in the index regardless of the market value or shares outstanding.

As the price which is very volatile factor in investing. When the stock price increases then weightage of the stock increases hence more funds are allocated due to higher weightage regardless of the actual size and no of shares outstanding.

From above elaboration of every index one can conclude than value index is more sutable to buy and hold strategy as its a passive strategy which involves holding a index for many number of years.

3) Option C is the correct answer,

Let us understand what pure discount bond and regular bond,

Pure discount bond = It is a bond which is issue at discount at the par value and no coupons are paid over the tenor of the bond and once it gets mature principal value is repaid.

In such bonds, interest rate investor receives is in the form of discount only and no coupons are paid.

Regular bond = Regular bond may or may not be issue at discount however regular coupon payments are paid to investors with repayment of the principal once bond gets mature.

From above two definitions one can understand, C is correct choice.