PPA FEB UI

Security Market
Indices
 LOS

describe a security market index;

calculate and interpret the value, price return, and total return of an index;

describe the choices and issues in index construction and management;

PPA FEB UI
compare the different weighting methods used in index construction;

calculate and analyze the value and return of an index given its weighting method;

describe rebalancing and reconstitution of an index;

CFA Course FEUI Level 1 2

 LOS

describe uses of security market indices;

describe types of equity indices;

describe types of fixed-income indices;

PPA FEB UI
describe indices representing alternative investments;

compare types of security market indices.

CFA Course FEUI Level 1 3

 Definition

represents the
security performance
market of an asset class,
security market,
index or segment of a
market

PPA FEBperformance
UI The of the
market or segment over a
period of time is represented by
the percentage change in
(i.e., the return on) the value
of the index
CFA Course FEUI Level 1 4
 Price vs total return index

Price index:
uses only the prices of the constituent
securities in the return calculation.
The rate of return is called a price
return.

PPA FEB UI
Total return index:
uses both the price of and the
income from the index securities in
the return calculation..

CFA Course FEUI Level 1 5

 Index construction and management
Decisions that index providers must make when constructing and managing
indexes include:

The target market the index will measure

Which securities from the target market to include

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The appropriate weighting method

How frequently to rebalance the index to its target

weights

How frequently to re-examine the selection and

weighting of securities

CFA Course FEUI Level 1 6

 Index construction methodology

• the arithmetic mean of the prices of the index securities.

price-weighted • The divisor is initially equal to the number of securities in the index
• The divisor must be adjusted for stock splits and changes in the composition of
index the index over time

equal-weighted • assigns the same weight to each of its constituent securities

index

market
capitalization-
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• gives each constituent security a weight equal to its proportion of the total
market value of all securities in the index
• Market capitalization can be adjusted for a security’s market float or free float
to reflect the fact that not all outstanding shares are available for purchase.
weighted index

• uses weights that are independent of security prices, such as company earnings,
fundamental- revenue, assets, or cash flow

weighted index

CFA Course FEUI Level 1 7

 Formula: Price-weighted index

Sum of stock prices

Price-weighted
index
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number of stocks in index adjusted for
splits

CFA Course FEUI Level 1 8

 Formula: Market capitalization-weighted index

current total market

value of index stocks
Market
capitalization-
weighted index
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base year total
base year
index value
market value of
index stocks

CFA Course FEUI Level 1 9

 Formula: Equal-weighted index

(1 + average percentage change in index stocks) × initial index

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CFA Course FEUI Level 1 10

 SOAL

Share Price Jan 1 Share Price Dec 31

Stock A $22 $28
Stock B $40 $50
Stock C $34 $30

PPA FEB UI
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%

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 JAWABAN

Share Price Jan 1 Share Price Dec 31

Stock A $22 $28

PPA FEB UI
Stock B $40 $50
Stock C $34 $30
Rata-Rata Aritmetik $32 $36

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 SOAL

Share Price Jan 1 Share Price Dec 31

Stock A $22 $28
Stock B $40 $50
Stock C $34 $30

PPA FEB UI
The 1-year return on a equal-weighted index of these
three stocks is closest to:
A. 12.0%.
B. 12.5%.
C. 13.5%

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 JAWABAN

Share Price Jan 1 Share Price Dec 31 Stock Return

Stock A $22 $28

PPA FEB UI
Stock B $40 $50

Stock C $34 $30

Rata-Rata Aritmetik (Return) 13.50%

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 SOAL

Share Price Number of Share Price Number of

Jan 1 Shares Jan 1 Dec 31 Shares Dec 31
Stock A $22 1,500 $28 1,500
Stock B $40 10,000 $50 10,000
Stock C $34 3,000 $30 3,000

PPA FEB UI
The 1-year return on a market-capitalization weighted
index of these three stocks is closest to:
A. 12.0%.
B. 13.5%.
C. 18.0%

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 JAWABAN

Market Cap
Jan 1 Share Price Number of Shares (Share Price x
Number of Shares)
Stock A $22 1,500 33,000
Stock B $40 10,000 400,000

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Stock C $34 3,000 102,000
Total Market Value (Jan 1) $535,000
Market Cap
Dec 31 Share Price Number of Shares (Share Price x
Number of Shares)
Stock A $28 1,500 42,000
Stock B $50 10,000 500,000
Stock C $30 3,000 90,000
Total Market Value (Dec 31) $632,000
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 JAWABAN

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 Rebalancing vs Reconstitution

Rebalancing
• adjusting the weights of securities in a portfolio to their
target weights after price changes have affected the
weights.
• This is most important for equal-weighted indexes..

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Index reconstitution
• changing the securities that are included in an index.
• This is necessary when securities mature or when they no longer
have the required characteristics to be included.

CFA Course FEUI Level 1 18

 Use of security market indices

Benchmark of
Reflection of Measure of
manager
market sentiment market return
performance

PPA FEB UI
Measure of beta Model portfolio
and excess return for index funds.

CFA Course FEUI Level 1 19

 SOAL

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.
PPA FEB UI
C. Using the CAPM to determine the expected return and
beta

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 JAWABAN

Comparing a small-cap manager against a broad market

would be an inappropriate use of an index. A benchmark
should be consistent with the manager's investment

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approach and style. A manager's performance will
depend to a large degree on its chosen style

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 Type of equity indices

Broad market equity indexes

• represent the majority of stocks in a market

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Multi-market equity indexes
• contain the indexes of several countries.
• Multi-market equity indexes with
fundamental weighting use market
capitalization weighting for the securities
within a country’s market but then weight
the countries within the global index by a
fundamental factor

CFA Course FEUI Level 1 22

 Type of equity indices

Sector indexes
• measure the returns for a sector (e.g., health care)
and are useful because some sectors do better
than others in certain business cycle phases

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• These indexes are used to evaluate portfolio
managers and as models for sector investment
funds

Style indexes
• measure the returns to market capitalization and
value or growth strategies.
• Stocks tend to migrate among classifications,
which causes style indexes to have higher
constituent turnover than broad market indexes

CFA Course FEUI Level 1 23

 Fixed income indices

Fixed-income indexes can be classified by issuer, collateral,

coupon, maturity, credit risk (e.g., investment grade versus
high-yield), and inflation protection

They can be delineated as broad market, sector, style, or

other specialized indexes. Indexes exist for various sectors,

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regions, and levels of development.

The fixed-income security universe is much broader than the

equity universe, and fixed-income indexes have higher
turnover.

Index providers must depend on dealers for fixed-income

security prices, and the securities are often illiquid. Fixed-
income security indexes vary widely in their numbers of
constituent securities and can be difficult and expensive to
replicate.

CFA Course FEUI Level 1 24

 SOAL

Which of the following is least accurate regarding fixed

Income indexes?
A. Replicating the return on a fixed income security index

PPA FEB UI
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 are easy to get.

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 JAWABAN

Fixed income securities are largely traded by dealers and

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trade infrequently. Data are therefore difficult to obtain.

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 Indices for alternative investment

• the weighting method

• different indexes can have vastly different commodity weights

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and resulting risk and return

• the fact that commodity indexes are based on the performance of

commodity futures contracts, not the actual commodities,
which can result in different performance for a commodity
index versus the actual commodity.

CFA Course FEUI Level 1 27

 Indices for alternative investment

include appraisal indexes, repeat property sales indexes, dan indexes of

real estate investment trusts.

PPA FEB UI
Because hedge funds report their performance to index providers
voluntarily, the performance of different hedge fund indexes can vary
substantially and index returns have an upward bias

CFA Course FEUI Level 1 28

 Types of security market indexes

Security market indexes available from commercial providers represent a

variety of asset classes and reflect target markets that can be classified by:

Geographic location • country, regional, or global indexes

Sector or industry
PPA FEB UI
• indexes of energy producers

Level of economic
• emerging market indexes
development

Fundamental factors • indexes of value stocks or growth stocks

CFA Course FEUI Level 1 29

 Example
Jumlah
Weighting
Indeks Mencerminkan constituent Catatan
method
securities
Saham AS
Dow Jones Saham dipilih oleh
berkapitalisasi 30 Price-weighted
Industrial Average WSJ editor
besar
Terdapat beberapa
saham tidak likuid,

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Saham Jepang
Nikkei Stock saham dengan
berkapitalisasi 225 Modified-price
Average harga tinggi
besar
bobotnya
disesuaikan
Semua saham Mencerminkan
Market
yang ada di Tokyo 93% saham di
TOPIX Berubah-ubah capitalization,
Stock Exchange- Jepang. Banyak
adjusted for float
First Section saham tidak likuid.
Saham di 23
Market Dibuat dalam USD
MSCI All Country negara maju dan
Berubah-ubah capitalization, dan mata uang
World Index 22 negara
adjusted for float lokal
beerkembang

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 Example
Jumlah
Weighting
Indeks Mencerminkan constituent Catatan
method
securities
S&P Developed
Saham Market
Ex-U.S. BMI Portofolio model
perusahaan energi Berubah-ubah capitalization,
Energy Sector untuk ETF
global di luar AS adjusted for float
Index
Barclays Capital Dulunya dihitung

PPA FEB UI
Obligasi global Market
Global Aggregate Berubah-ubah oleh Lehman
investment-grade capitalization
Bond Index Brothers
Mencerminkan
liquid portion di
Markit iBoxx Euro
Obligasi di bawah Market pasar dan
High-Yield Bond Berubah-ubah
investment-grade capitalization dilakukan
Indexes
rebalancing setiap
bulan
Mencerminkan
FTSE EPRA/NAREIT Market
REITs yang
Global Real Estate Real estate global 335 capitalization,
diperjualbelikan di
Index adjusted for float
bursa

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 Example

Jumlah
Weighting
Indeks Mencerminkan constituent Catatan
method
securities
Berisi macam-macam
hedge fund
strategies dan
HFRX Global Hedge
Global hedge funds Berubah-ubah Asset-weighted dibobot berdasarkan
Fund Index
jumlah yang

PPA FEB UI
diinvestasikan dalam
hedge fund
Isinya sama dengan
HFRX Equal
atas tetapi bobot
Weighted Strategies Global hedge funds Berubah-ubah Equal-weighted
menggunakan equal-
EUR Index
weighted
9 kategori
Saham perusahaan diklasifikasikan
AS dikelompokkan Market berdasarkan
Morningstar Style
berdasarkan Berubah-ubah capitalization, kombinasi 3 kategori
Indexes
value/growth dan adjusted for float market cap dan 3
market cap kategori
value/growth

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 SOAL

Income securities are relatively easy to obtain. Most of

the widely used global security indexes are:
A. price-weighted.

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B. equal-weighted.
C. market capitalization-weighted

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 JAWABAN

Most global security indexes are market capitalization-

weighted with a float adjustment to reflect the amount of

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shares available to investors.

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