Question

Suppose, during a given year, the return on an equal-weighted portfolio consisting of the 500 stocks in the S&P 500 is lower than the actual return on the S&P 500 (which is value-weighted). This means that the return of smaller stocks is _________ the return of larger stocks during the year.

A) higher than B) lower than C) equal to D) more volatile than

Answer 1

Option (B) : Lower than

Explanation:

The value-weighted portfolio created out of all S&P stocks have all the stocks whether smaller cap or larger cap in equal proportion based on the weights given on the basis of their market cap.

However, the actual S&P index comprises of stocks in proportion to their market value weights. In other words, the stocks withb highest market cap has the highest weight and hence the highest proportion.

Now, since the return on actual S&P exceeded the portfolio return, it means that the returns of large cap stocks were higher than the lower cap stock.

i.e. Return on smaller stocks is lower than the return on larger stocks.