WEBVTT 00:01.600 --> 00:08.800 In this next video we will examine and create the equal weighted index and the idea behind it is pretty 00:08.800 --> 00:12.360 simple so all constituents in the index are equal weighted. 00:12.490 --> 00:19.210 And that means equal weighted in monetary terms and actually the intuitions that we invest equal dollar 00:19.210 --> 00:21.490 amounts into each constituent. 00:21.580 --> 00:28.370 So the easiest example is to have only two constituents and a total investment sum of two thousand dollars. 00:28.390 --> 00:35.460 Then we invest 50 percent of our investment sum into a stock A and 50 percent to stock B. 00:35.530 --> 00:40.990 So let's have a look at an easy example with some numbers and it's actually here the same example as 00:40.990 --> 00:41.970 before. 00:42.010 --> 00:44.230 So we have two timestamps and two stocks. 00:44.230 --> 00:46.960 And here we have the prices. 00:46.960 --> 00:51.400 And then we can also create uh the uh simple returns. 00:51.460 --> 00:57.550 So of course we fear a timestamp zero no returns and also no weighted average return. 00:57.730 --> 01:01.160 And the base value of our index shall be 100. 01:01.270 --> 01:08.110 And then we calculate the returns for the period from timestamp 0 to 1 and it's 60 percent for stock 01:08.110 --> 01:15.460 A and minus 20 percent for stock P and then we have to calculate the weighted average return of stock 01:15.490 --> 01:16.520 A and B. 01:16.630 --> 01:22.660 And as we have equal weighting and an equal weighted index then consequently we have to wait the returns 01:22.660 --> 01:27.450 of stock A and Stock B with the 50 percent or O point five. 01:27.760 --> 01:33.130 And we get a weighted average return for that period of 20 percent. 01:33.130 --> 01:40.060 And finally starting with an index value of 100 and having 20 percent return and the first period gives 01:40.060 --> 01:45.250 us an index value at the end of the first period of 120. 01:45.280 --> 01:53.920 So we simply multiply 100 by one plus 20 percent so that's how we calculate the indexed value at the 01:53.950 --> 01:55.420 time stamp on. 01:55.510 --> 02:00.370 And now let's go to a more general example with more periods. 02:00.370 --> 02:05.810 So we have two periods so here we have in addition the timestamp too. 02:05.990 --> 02:13.770 And still we have the returns here and again our base value at the time stamp zero should be 100. 02:13.820 --> 02:19.970 And now for the period from timestamp bond to timestamp 2 we have a return for stock a of minus 10 percent 02:20.300 --> 02:26.030 and a return of 30 percent for stock B and therefore a weighted average return for that period of 10 02:26.030 --> 02:27.320 percent. 02:27.380 --> 02:32.620 And as you can see here we have an additional column cumulative investment multiple. 02:33.140 --> 02:39.020 And for the first period the cumulative investment multiplier is simply the return of the very first 02:39.020 --> 02:45.260 period 20 percent plus one gets on point two and by multiplying one point two. 02:45.260 --> 02:53.040 With the initial index value 100 gives us the 120 and let's go on and calculate the cumulative investment 02:53.040 --> 02:56.480 multiple and the indexed value for timestamp 2. 02:56.490 --> 03:01.280 And the calculation of the cumulative investment multiple is pretty straightforward. 03:01.290 --> 03:07.410 So we have two periods and then one period we have 20 percent return average and a one period 10 percent 03:07.890 --> 03:14.590 and the cumulative investment multiple is simply one plus 20 percent times one plus the 10 percent gifts. 03:14.700 --> 03:16.930 Uh one point uh three two. 03:17.490 --> 03:23.880 And by multiplying the cumulative investment multiple with the initial indexed value one hundred gives 03:23.880 --> 03:29.880 us actually the indexed value at the time stamp to one hundred thirty two. 03:30.600 --> 03:37.320 And lastly if I look at the pros and cons of the equal weighted index and one main advantage of the 03:37.320 --> 03:45.040 equal weighted indexes so that by definition the equal weighted index shows a maximum degree of diversification. 03:45.120 --> 03:52.640 So we have no concentrated positions as our constituents have the same rate and second also the equal 03:52.640 --> 03:55.030 weighted index is pretty intuitive. 03:55.370 --> 04:00.620 So we have an equal investment amount invested in each constituency. 04:00.720 --> 04:04.530 And now let's go also to the disadvantages. 04:04.670 --> 04:10.830 So typically the performance of the equal weighted index is biased towards the smaller stocks as smaller 04:10.860 --> 04:16.760 stocks have a higher proportion or higher weight in the equal weighted index than they would have in 04:16.760 --> 04:19.310 a price weighted or evaluated index. 04:19.460 --> 04:24.770 And typically smaller stocks show higher risk but sometimes also higher return. 04:24.830 --> 04:33.530 So typically an equal weighted index is riskier riskier and also here the market capitalization better 04:33.530 --> 04:36.230 reflects a company's economic importance. 04:37.420 --> 04:44.080 And another point is that typically the equal weighted index does not reflect typical portfolio construction. 04:44.110 --> 04:49.510 So investors rarely invest equal amounts and to constituents. 04:49.510 --> 04:51.380 And finally and this is a big point. 04:51.370 --> 04:59.320 An equal weighted index or a portfolio that follows an equal weighted index requires constant rebalancing. 04:59.320 --> 05:06.040 So let's assume that we invest a 100 dollar in stock a 100 dollar and stock B and in the first period 05:06.070 --> 05:11.650 the price of stock a increases and the price of stock B decreases. 05:11.650 --> 05:16.130 So in this case the rates are actually no longer 50/50 or equal. 05:16.520 --> 05:22.110 And we would be required to rebalance so we as sell winners and buy losers. 05:22.220 --> 05:26.980 And this means actually high transaction costs and also Texas. 05:26.980 --> 05:32.920 So from a practical point of view the equal weighted index is actually not the best choice. 05:33.100 --> 05:37.390 And with this we are finished here and I hope to see also in the next videos by.