Fin 423
Stock market Indices
o
Price-weighted index
Advantages: cheap, easy to track the indices
Disadvantages: only 30 companies (DJIA) and price-
weighted
Stock Split Adjustment – Change the divisor
o
Value-weighted index: follow a passive strategy and better than
Price-weighted
Only reflect capital gains not cash payments (but u can
calculate on your own)
Advantages: company value drives the index, cheap easy
and efficient
Disadvantages: the index is top-heavy not super diversified
if the market is not completely efficient, some stock price
is misplaced, then the index will underperform because
the manager will hold too much of overpriced stocks and
too little of underpriced stocks.
o
Equal-weighted Index: selling winner and buying losers (long
term horizon)
Advantages: overcome market inefficiency by buying more
underpriced and buying less overpriced. Find the true price
Disadvantage: trade a lot/ less tax efficient, really hard to
do equal weight with small companies
Equal weighted: risker and more returns cuz investment in
small firms

Risk and Returns (09/16)
o
Net Return or Holding Period Return
o
Gross Return (Net return +1)
o
Income Yield = div/P
o
Capital Gain
o
Real Returns: adjusted due to inflation
Germany VS Brazil: Germany has the higher real rate of
return, cuz lower inflation rate
o
After tax return: marginal tax rate
o
Compounding Returns
Arithmetic average returns (15%)
Geometric average returns (CAGR) always lower than the
mean due to compounding
The longer the horizon the bigger the variance the