CFA Level I · CFA Level I Exam · Benchmarking Returns
A value-weighted index has two stocks. Stock A has a market capitalization of 600 million and returned 10%. Stock B has a market capitalization of 400 million and returned -5%. Using beginning-of-period capitalizations, the index return is closest to:
The index return is about 4.0%. Beginning weights are 60% and 40%, so the return is 0.6 times 10% plus 0.4 times negative 5%, which equals 6% minus 2%. The simple average of 2.5% wrongly ignores market-cap weights.
- A2.5%
- B4.0%Correct
- C5.0%
Explanation
Weights are 60% for A and 40% for B. Return = 0.6×10% + 0.4×(-5%) = 6% - 2% = 4.0%. The simple average of 2.5% ignores the weights, and 5.0% ignores B's negative return mix.
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