Security Analysis

Section: Security Market Indices and Equity Analysis Estimated study time: 45 minutes Content: Security market indices track the performance of a group of securities representing a market, market segment, or asset class. They serve as benchmarks for portfolio performance, as the underlying for index funds and ETFs, and as economic indicators. Indices differ in their construction methodology — specifically in how securities are weighted. A price-weighted index (like the Dow Jones Industrial Average) weights each security by its price per share; a higher-priced stock has more influence on the index regardless of its market cap. A market-capitalization-weighted index (like the S&P 500) weights securities by their total market capitalization; larger companies have more influence. A float-adjusted market-cap weighted index uses only the publicly tradeable shares (excluding insider holdings and government blocks). Equal-weighted indices assign the same weight to all constituents, requiring periodic rebalancing as prices diverge. Index construction choices have significant performance implications. Price-weighted indices are biased toward high-priced stocks regardless of company size — a stock split reduces a company's influence without any change in its economic significance. Market-cap-weighted indices give more weight to stocks that have already risen (momentum bias) and concentrate the index in large-cap stocks. Equal-weighted indices overweight small-cap stocks relative to their economic size and require more frequent, costly rebalancing. For CFA exam purposes, knowing the formula for calculating returns and weights under each method — and understanding the biases of each — is essential. Reconstitution (periodic updates to index membership) and rebalancing (resetting weights to target) are also tested concepts. Fundamental analysis is the core approach to equity security analysis. It involves estimating the intrinsic value of a security by analyzing quantitative factors…