Guys,
I am in the final phase of an interview for an Equity Index Research position. Got a question, please help me out.
What’s the impact from a cash dividend payment on Equity Index? Under the following link, on P.48, they mention that a cash dividend would have an impact on a Total Return Index but not in a Price Return index. Why is that?
In my view, the Price Return index would be impacted as the share price would drop following the cash dividend payment, no?
Thank you!
Sorry, find the link below:
I think total return incorporates dividends that are reinvested and price return index does not incorporate reinvestment of dividends?
That is correct, but why doesn’t a dividend payment impact Price Indexes if the stock price drops on the ex-date?
Price indices are calculated using the price performance of constituents and it completely ignores the dividend payouts by companies. On the other hand, total return indices include the dividends while calculating the index performance. Total return indices account for ordinary cash dividends and are generally applied on the ex-date. Regular cash distributions are generally not considered in price return indices, except for capital repayments and special dividends which are deemed extraordinary. I think you are right in concept but it is kinda embedded in the price already so no additional adjustment would need on the ex-dividend date, it would however have an impact on the index.
From Level 1
PRI=(VPRI1−VPRI0)/VPRI0
where
PRI = the price return of the index portfolio (as a decimal number, i.e., 12 percent is 0.12)
VPRI1 = the value of the price return index at the end of the period
VPRI0 = the value of the price return index at the beginning of the period
TRI=(VPRI1−VPRI0+IncI)/VPRI0
where
TRI = the total return of the index portfolio (as a decimal number)
VPRI1= the value of the price return index at the end of the period
VPRI0 = the value of the price return index at the beginning of the period
IncI = the total income (dividends and/or interest) from all securities in the index held over the period
Whatever effect the dividend has on the stock price is reflected in both indices, except TRI also has that one additional component in the numerator.
That’s what I thought, but did you take a quick look at P48 in the link I posted?
It says the following: “For index calculation purposes, a regular dividend will only have an effect on the Total Return (TR) and Net Total Return (Net TR) indices and not on Price Return indices”
Yes I read that. Every other source seems to define the indices likewise without further elaboration. Probably what everyone assumes is that dividends affect prices of stocks but since all indices incorporate this price change then it can be cancelled out.