A popular value-weighted index is constructed out of shares in the two companies,shown in the table below.On Day 1 you construct a portfolio that mimics the index with 15% invested in Company 1 and 85% invested in Company 2.On Day 2,what trades do you need to make in order to adjust your portfolio weights so that your portfolio earns the same return as the index from Day 2 to Day 3?

A) Buy more of Company 1 and buy more of Company 2
B) Buy more of Company 1 and sell some of Company 2
C) Sell some of Company 1 and sell some of Company 2
D) Sell some of Company 1 and buy more of Company 2
E) Make no trades

Question

A popular value-weighted index is constructed out of shares in the two companies,shown in the table below.On Day 1 you construct a portfolio that mimics the index with 15% invested in Company 1 and 85% invested in Company 2.On Day 2,what trades do you need to make in order to adjust your portfolio weights so that your portfolio earns the same return as the index from Day 2 to Day 3?

A) Buy more of Company 1 and buy more of Company 2 
B) Buy more of Company 1 and sell some of Company 2 
C) Sell some of Company 1 and sell some of Company 2 
D) Sell some of Company 1 and buy more of Company 2 
E) Make no trades

Quizplus · Accepted Answer

No trades are necessary. The weights will change from Day 1 to Day 2 as the relative prices of the two stocks change. The weights will change automatically, and the portfolio will continue to track the index in the second period without any adjustments.

A Popular Value-Weighted Index Is Constructed Out of Shares in the Two