NISM Certifications · NISM-Series-VIII: Equity Derivatives · Understanding Index
When a stock is replaced in a market-capitalisation weighted index, which adjustment keeps the index value continuous on the day of change?
The index divisor, or base market capitalisation, is adjusted so the index value stays continuous when constituents change. This prevents an artificial jump or fall caused purely by the replacement, ensuring index movements reflect only genuine price changes of the stocks.
- AThe index value is reset to the base value
- BThe index divisor (base market capitalisation) is adjustedCorrect
- CAll other stock prices are adjusted
- DNothing is adjusted since the index is price based
Explanation
When constituents change, the market cap changes abruptly without any price movement. To avoid a jump in the index, the base market capitalisation or divisor is adjusted proportionally. Resetting to base or adjusting prices would distort the index.
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