The Difference in Calculations of S&P 500 Index Returns Explained

Explanation

The difference in the two calculations of return, as observed by Mike Bowers, can be best explained by the composition and weighting of the stocks within the S&P 500 index.

The S&P 500 index is a widely recognized benchmark for the U.S. stock market, and it consists of 500 large-cap stocks selected by Standard & Poor's. The index's return is typically reported based on market capitalization weighting, which means that the performance of each stock is proportionally weighted by its market value. However, Mike Bowers recalculated the returns on an equally weighted basis, where each stock within the index is given the same weight.

Now, let's analyze the answer choices:

A. Large capitalization stocks outperforming small capitalization stocks: If large-cap stocks had outperformed small-cap stocks during the period, it would have resulted in higher returns for the S&P 500 index when calculated using market capitalization weighting. However, the recalculated returns by Bowers were lower than the officially reported returns. Therefore, this answer choice does not explain the difference in returns.

B. Small capitalization stocks outperforming large capitalization stocks: If small-cap stocks had outperformed large-cap stocks during the period, it would have resulted in higher returns for the equally weighted calculation. This could explain why Bowers estimated a lower return compared to the officially reported return. Therefore, this answer choice is a plausible explanation for the difference in returns.

C. The interest expenses on margin accounts: The interest expenses on margin accounts are not directly related to the calculation of returns for an index. While margin accounts allow investors to borrow money to invest, and the interest expenses on those loans can affect individual investor returns, they do not explain the difference between the officially reported return and Bowers' recalculated return for the S&P 500 index. Therefore, this answer choice is not the best explanation for the observed difference.

Considering the explanations above, the best explanation for the difference in the two calculations of return is that small capitalization stocks outperformed large capitalization stocks during the period, resulting in a higher return when the stocks were equally weighted. Therefore, the correct answer is B. small capitalization stocks outperforming large capitalization stocks.