4. Consider the three stocks in the following table. Pt represents price at time

Question

4. Consider the three stocks in the following table. Pt represents price at time t, and Qt represents shares outstanding at time t. Stock C splits two-for-one in the last period. P0 Q0 P1 Q1 P2 Q2 A 85 150 90 150 90 150 B 40 600 35 600 35 600 C 70 100 80 100 40 200 ________________________________________ Calculate the rate of return on a price-weighted index of the three stocks for the first period (t = 0 to t = 1). (5 points) b. What must happen to the divisor for the price-weighted index in year 2? (10 points) c. Calculate the rate of return of the price-weighted index for the second period (t = 1 to t = 2). (5 points)

Explanation / Answer

a)rate of return on a price-weighted index of the three stocks for the first period (t = 0 to t = 1).

At t = 0, the value of the index is: (85+ 40 + 70)/3 = 65

At t = 1, the value of the index is: (90+35+80)/3 = 68.3333

The rate of return is: (68.3333/60) – 1 = 5.13%

c)rate of return of the price-weighted index for the second period (t = 1 to t = 2).

At t = 1, the value of the index is: (90+35+80)/3 = 68.3333

At t = 2, the value of the index is: (90+35+40)/3 = 55

The rate of return =55/68.33-1=-19.51%

P0 Q0 P1 Q1 P2 Q2 A 85 150 90 150 90 150 B 40 600 35 600 35 600 C 70 10 80 100 40 200

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