Market Efficiency for Fundamental Anal ...
The table below shows if abnormal returns can be earned through various strategies... Read More
Index providers generally take a top-down approach to constructing a portfolio by defining:
Depending on the index, the target market may be defined broadly or narrowly based on asset class, geographic region, exchange, and/or other characteristics (sector, size, style, duration, credit quality).
Constituent securities are then selected from the available universe of securities in the given target market. Some indices may limit the number of securities to a certain amount, while others may have their number of holdings vary over time. Finally, the securities are weighted based on price, equal weights, market capitalization, or fundamentals (book value, cash flow, revenues, earnings, dividends, and the number of employees).
We will see those different weighting methods and the rebalancing methods commonly used in the next learning objectives.
Question
Which of the following is NOT usually a part of the standard index construction process?
- Determining an appropriate benchmark for the index.
- Deciding when the index portfolio should be rebalanced.
- Deciding how to weight constituent securities within the index.
Solution
The correct answer is A.
Most of the time, an index can serve as a benchmark but does need to establish a benchmark for its own performance.