In addition to price-weighted and value-weighted indexes, an equally weighted in

Question

In addition to price-weighted and value-weighted indexes, an equally weighted index is one in which the index value is computed from the average rate of return of the stocks comprising the index. Equally weighted indexes are frequently used by financial researchers to measure portfolio performance.

The following three defense stocks are to be combined into a stock index in January 2010 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance):

Compute the rate of return on an equally weighted index of the three defense stocks for the year ending December 31, 2010. (Negative amounts should be indicated by a minus sign. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

If the index value is set to 100 on January 1, 2010, what will the index value be on January 1, 2011? (Round your answer to 2 decimal places.)

What is the rate of return on the index for 2011? (Round your answer to 2 decimal places. Omit the "%" sign in your response.)

The following three defense stocks are to be combined into a stock index in January 2010 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance):

Explanation / Answer

Part A

Index value = sum of shares x price

Index value Jan 1, 2010 = (535 x 89 + 450 x70 + 230 x 99)

                                                = $101,885

Index value on 1 Jan 2011 = (535 x 94 + 450x65 + 230 x88)

                                                     = 99780

Index Return = Index value on Dec 31, 2010/ Index value on Jan 1, 2010   -1

                          = 99,780 / 101,885 -1

                          = -2.07%

Part B

Index value on Jan 1, 2011 = Initial Index value (1+ return)

                                                      = 100 x (1-0.0206605)

                                                       = 97.93

Part C

Index value Dec 31, 2011 = (535 x109 + 450x79 + 230 x105)

                                                   = 118015

Index return in 2011 = Index value Dec 31, 2011/ Index value Jan 31, 2011 -1

                                        = 118015/99780 -1

                                        = 18.28%

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