ERC Fund has chosen to index a portion of its large endowment fund to the S&P 500 index. The finance director wants to minimize ongoing rebalancing costs and tracking error. Which indexing strategy that best meets the objective: A) Full Replication B) Stratified Sampling C) Optimization
A? Anything less than 1000 stock should go for full replication.
A -(if he does not care about complexity and/or transaction (initiation) costs)
A. god i wish questions on 6/5 would be this easy.
A is right. I am confused between initial cost Vs rebalancing costs.
full replication costs more initially because your buying everything in the index (so for S&P 500 your buying all 500 companies in the relevant weights) but you don’t have to re balance it, because you essentially own the index, so you’ve only gotta sell and buy when the index composition changes. it’s a bigger deal with bonds where there are illiquid or thinly traded issues as part of the index, thats when full replication is really expensive and/or in practical to implement.
I failed last year because of the questions like these. Very easy but a simple twist. Seems to be happening again.