Hi all
I’m confused by the answer of a Kaplan practice question in V1 Exam 2 Morning
The question asks:
"A stock index consists of two stocks. As of January 1:
- Company A has 50 shares outstanding valued at $2 each.
- Company B has 10 shares outstanding valued at $10 each.
- The price-weighted index is 6, and the value-weighted index is 100.
On June 30, the price of Company A’s stock has increased to $4 per share. Effective the morning of July 1, Company B’s stock splits two-for-one and is priced at $5. The opening values of the price-weighted index and the value-weighted index on July 1 are:
- A: Price-Weighted: 7 / Value-Weighted: 150
- B: Price-Weighted: 7 / Value-Weighted: 125
- C: Price-Weighted: 4.5 / Value-Weighted: 150"
The answer given is A but I don’t agree with the price-weighted index number and associated reasoning: “Price-weighted index = 4 + 10 / 2 = 7. A price-weighted index is not affected by a split. The divisor is adjusted to account for the price change.”
My understanding is that a price-weighted index is affected by a split, and when the stock splits, you need to go back to the original weighting and back-calculate the new divisor. So I get 2 + 5 / x = 6 so X = 1.167. Then when I flow that through the updated numbers I get 4 + 5 / 1.167 = 7.71 (which isn’t one of the options).
Any help much appreciated.