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 2016 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance):

		Price
	Shares (millions)		1/1/16			1/1/17			1/1/18
Douglas McDonnell	215		$	64		$	68		$	82
Dynamics General	455			72			64			78
International Rockwell	250			101			90			106

a. Compute the rate of return on an equally weighted index of the three defense stocks for the year ending December 31, 2016. (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

b. If the index value is set to 100 on January 1, 2016, what will the index value be on January 1, 2017? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. What is the rate of return on the index for 2017? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

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Answer:

a) 1/1/16: Average of three stocks = (64 + 72 + 101)/3 = 79

1/1/17: Average of three stocks = (68 + 64 + 90)/3 = 74

Index Return = 74/79 - 1 = -6.33%

b) If index value was set at 100 in 2016, the index value in 2016 will be

=100 * (1 - 6.33%) = 93.67

c) 1/1/7: Average of three stocks = (68 + 64 + 90)/3 = 74

1/1/18: Average of three stocks = (82 + 78 + 106)/3 = 88.67

Index Return = 88.67/74 -1 = 19.82%