Purpose and Steps in Industry and Comp ...
Recall that industry and competitive analysis is the second step in the company... Read More
Index managers must consider when the index should be rebalanced and when the security selection and weighting decisions should be re-examined.
Rebalancing
Rebalancing refers to adjusting the weights of the constituent securities in the index on a regularly scheduled basis – usually quarterly. Price-weighted indices are not rebalanced, and rebalancing is a minor concern for market capitalization indices as they mostly rebalance themselves.
Reconstitution
Reconstitution is the process of changing the constituent securities in an index. Since many indices base their portfolio allocation on a set of criteria, the securities that meet the criteria tend to change over time. Securities that no longer meet the criteria are excluded on the reconstitution date, and new securities are included. Oftentimes, the reconstitution will require further rebalancing as the turnover of securities changes the targeted allocations. Expected inclusion of certain securities in a widely-tracked index tends to drive prices up while expected exclusion tends to drive prices down in anticipation of future purchases or sales of related index funds.
Question
If a company in a market-capitalization index with a market capitalization of $15 billion at quarter-end will be replaced by a company with a market capitalization of $17.5 billion, what effect would the reconstitution have on the other companies within the index?
- Allocations would stay the same.
- Allocations to other companies would increase.
- Allocations to other companies would decrease.
Solution
The correct answer is C.
Since the company to be added has a higher market capitalization than the one being kicked out of the index, the new company will be weighted more heavily thus reducing allocation to all other companies within the index.
A is incorrect. This is because the total weight allocated to the index constituents changes with the inclusion of a new company.
B is incorrect. This is because adding a higher market capitalization company means reducing the relative weight of existing companies in the index, not increasing it.
Sergio Torrico
2021-07-23
Excelente para el FRM 2
Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé
AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
diana
2021-07-17
So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts.
The fun light-hearted analogies are also a welcome break to some very dry content.
I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
Kriti Dhawan
2021-07-16
A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them.
Thank you ! Grateful I saw this at the right time for my CFA prep.
nikhil kumar
2021-06-28
Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
Marwan
2021-06-22
Great support throughout the course by the team, did not feel neglected
Benjamin anonymous
2021-05-10
I loved using AnalystPrep for FRM.
QBank is huge, videos are great.
Would recommend to a friend
Daniel Glyn
2021-03-24
I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
michael walshe
2021-03-18
Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.