Price Weighted Index Denominator effect?

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TheDubs

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Hoping someone can give me some insight here. I am working from schweser and this concept has me a little confused. Schweser page 137 Book 4 states “”Once a price weighted index is established, the denominator must be adjusted to reflect stock splits and changes in the sample over time”……Just wondering if someone could walk me through an example on how the denominator is effcted by a stock split. I recall a question on the June exam that discussed the effect of a stock split on the denominator (which i’m sure I got wrong being that I am here again in December)…..I used the search and saw a bit of conversation on this a few days back, but still am a little confused…..Any help you could provide would be greatly appreciated…….Thanks
Dubs
 
example
before 3 stocks 100 15 25
Price weighted index = 100 + 15 + 25 / 3 = 140/3 = 46.67
Say Stock 3 underwent a split and the new price became 5 $
100 + 15 + 5 / 46.67 will be the new divisor –> So new divisor would be 2.571
to ensure that the Index remains the same.
 
Assume google share is 350 and micorsoft 100
Index = 350+100/2 = 225
In case google announces a stock split
new index would have been 175 + 100 /2 = 275/2 = 137.5 which means that the index decreased although it shouldnt have since google’s shares didnt go down bcoz of market movement.
We need to keep 225 index as it is.
so we have 275/x = 225
X should now be lower than 2. in this case 1.07 . The divisor decreased. Hope this helps
 
yep the guys got it down the thing is that you shouldn’t have a change in index price from ending day1 to beg day2 because of stock splits, dividends, aquisitions mergers etc
 
Thanks a lot for taking the time guys……l got it now!!!!!!. I love crunch time you get answers within 5 minutes on this board! I don’t think schweser covered this well….or maybe I’m just slow…haha. Good Luck with your studying
Dubs
 
what happens if there is a stock split and also one of the stocks rise in price?
example 3 stocks..
$10
$20
$30
index = 10+20+30 / 3 = 20
if second stock splits 2 for 1
index is 10 + 10 + 30 / x = 30
solve for x to keep the index the same.. i understand that ..
but what if the firt stock also increased in price to say 15..
then is it 15 + 10+ 30 / x = 30?
dont we have to adjust the index for the change in the first stocks price?
 
The index changes because of the rise in stock price but that’s not an adjustment. You keep the prices the same and adjust your denominator as given above. Then change the prices and recalculate the index.
 
How about if they want to replace an old stock with a new one? Is there any change in index value because of the replacement?
 
it shouldn’t i think they correct it also with the coefficient
changing the value of an index because of a structural change would defeat the purpose of the index
just an opinion
 
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