Are Johnson's Statements Correct?

A

Let's analyze each statement separately:

Statement 1: "We should use an unweighted index because it would best reflect the large company bias in the portfolio."

This statement is incorrect. An unweighted index does not take into account the market capitalization of the companies included in the index. In a large capitalization equity mutual fund, the portfolio typically consists of stocks of large companies. Market capitalization is the total value of a company's outstanding shares and is often used as a measure of a company's size. Since the portfolio is biased towards large companies, it would be more appropriate to use a market-capitalization-weighted index as a benchmark. This type of index assigns higher weights to larger companies, which better reflects the composition of the portfolio.

Statement 2: "Stocks in the portfolio frequently split the number of shares outstanding. Therefore, in the long run, the Dow Jones Industrial Average would best reflect these events."

This statement is also incorrect. The Dow Jones Industrial Average (DJIA) is a price-weighted index, which means that the stock prices of the companies in the index are the main determinant of their influence on the index. Stock splits, which increase the number of shares outstanding while decreasing the share price proportionally, do not affect the price-weighted calculation of the DJIA. Therefore, the DJIA does not accurately reflect the impact of stock splits on the performance of the portfolio.

In summary, Johnson's two statements are both incorrect. The appropriate benchmark for a large capitalization equity mutual fund with a bias towards large companies would be a market-capitalization-weighted index, and the Dow Jones Industrial Average is not the best benchmark to reflect the impact of stock splits.