Extremely confused, on what should be one of the easier concepts…please help…
A stock index consists of 2 stocks: Company A has 50 shares outstanding at $2 each. Company B has 10 shares outstanding valued at $10 each. THe price-weighted index is 6, and market weighted index is 100.
If the price of Company A’s stock increases to $4 per share, and Company B’s stock splits 2 for 1 and is priced at $5, the value of the price-weighted index and value weighted index are?
Answer: Price weighted = 7, Value Weighed = 150.
The answer states “A price weighted index is not affected by a split (4+10)/2 = 7. The divisor is adjusted to account for the price change”
I don’t understand this whatsoever. First off, if it’s not affected, how is the divisor adjusted. Secondly, If the price weighted index was originally 6, wasn’t that just (2+10)/2 =6. If that is correct, in both cases the divisor is 2?
I’ve spend way too much time trying to figure this out, including looking at definition of price weighted index which states (sum of stock prices)/number of stocks in index. Which if I try to calculate I get [(50x4)+(20x5)]/70 = 4.2?