2. A market cap weighted broad based equity index such as the S&P500 is often used as a proxy for the market portfolio that is defined in the CAPM. Select the following statement that is least correct about cap weighted indices in this context a. A cap weighted index is biased towards large cap firms b. A cap weighted index is rarely the Maximum Sharpe ratio portfolio c. A cap weighted index is biased towards low volatility firms d. A cap weighted index is typically under-diversified to what would be expected e. A cap weighted index is biased towards growth firms
Question
- A market cap weighted broad based equity index such as the S&P500 is often used as a proxy for the market portfolio that is defined in the CAPM. Select the following statement that is least correct about cap weighted indices in this context a. A cap weighted index is biased towards large cap firms b. A cap weighted index is rarely the Maximum Sharpe ratio portfolio c. A cap weighted index is biased towards low volatility firms d. A cap weighted index is typically under-diversified to what would be expected e. A cap weighted index is biased towards growth firms
Solution
The statement that is least correct about cap weighted indices in this context is:
c. A cap weighted index is biased towards low volatility firms
This statement is least correct because a cap weighted index is not necessarily biased towards low volatility firms. In fact, it can be argued that it is biased towards high volatility firms as these firms often have larger market capitalizations. The weight of each company in a cap weighted index is determined by its market capitalization, not its volatility. Therefore, a company with a larger market cap will have a greater influence on the index, regardless of its volatility.
Similar Questions
2. A market cap weighted broad based equity index such as the S&P500 is often used as a proxy for the market portfolio that is defined in the CAPM. Select the following statement that is least correct about cap weighted indices in this context a. A cap weighted index is biased towards large cap firms b. A cap weighted index is rarely the Maximum Sharpe ratio portfolio c. A cap weighted index is biased towards low volatility firms d. A cap weighted index is typically under-diversified to what would be expected e. A cap weighted index is biased towards growth firms
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