Which of the following index is known as value weighting?
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A. B. C. D.D
The index that is known as value weighting is D. Capitalization weighting.
Value weighting, also referred to as market capitalization weighting, is a method of determining the composition of an index based on the market capitalization of the individual components. Market capitalization is calculated by multiplying the price of a company's outstanding shares by the number of shares available in the market.
In a value-weighted index, each component's weight is determined by its market capitalization relative to the total market capitalization of all the components in the index. In other words, larger companies with higher market capitalizations have a greater impact on the index's performance compared to smaller companies.
This approach reflects the market's valuation of each company, as it takes into account the total market value investors are assigning to each company's stock. As a result, companies with larger market capitalizations have a larger influence on the index's movements.
By contrast, let's briefly explain the other answer choices:
A. Price weighting: In a price-weighted index, the components are weighted based on their stock prices. The higher the stock price, the greater its impact on the index. This means that changes in the price of higher-priced stocks will have a larger effect on the index, regardless of the company's market capitalization.
B. Equal weighting: In an equal-weighted index, each component is assigned an equal weight regardless of its market capitalization or price. This approach treats all stocks equally, regardless of their size or price, resulting in an equal impact from each stock on the index's performance.
C. Base weighting: Base weighting is not a commonly used term in the context of index weighting methods. It is possible that this term has a specific meaning within the context of the CTFA exam or the ABA, but without further information, it is difficult to provide a specific explanation.
To summarize, the value weighting method, also known as capitalization weighting, determines the composition of an index based on the market capitalization of each component. It reflects the market's valuation of each company, with larger companies having a greater influence on the index's performance.