Divisors for Adjusting Stock Splits

B

The correct answer is B. Price weighting.

Price weighting is a stock market index weighting method that assigns a higher weight to stocks with a higher price per share. This means that stocks with a higher price have a greater influence on the overall value of the index. However, price weighting can be affected by stock splits.

When a company's stock splits, the number of shares outstanding increases, but the total market value of the company remains the same. As a result, the price per share decreases. If a price-weighted index does not adjust for stock splits, it may falsely indicate a decline in the overall value of the index.

To address this issue, a divisor is used to adjust the index for stock splits. The divisor is a number that is adjusted whenever a stock in the index splits. The new divisor is calculated by dividing the previous divisor by the stock split ratio. This ensures that the overall value of the index remains the same before and after the stock split.

For example, let's say that a price-weighted index has a divisor of 10 and contains two stocks, A and B. Stock A has a price of $50 per share and stock B has a price of $100 per share. The index value would be (50 + 100) / 10 = 15. Now, let's say that stock A has a 2-for-1 stock split, which means that the number of shares outstanding doubles and the price per share is halved to $25. To adjust the index for the stock split, the divisor is divided by 2, which gives a new divisor of 5. The index value after the stock split would be (25 + 100) / 5 = 25, which reflects the same overall value of the index before the stock split.

In contrast, capitalization weighting, equal weighting, and base weighting do not use a divisor to adjust for stock splits as they do not rely on the price per share as a weighting factor.